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Economic Growth
Foreign Direct Investment, Trade and
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 Foreign Direct Investment, Trade and
Economic Growth
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Challenges and Opportunities

Editor
SHAHID AHMED
 First published 2013 in India
by Routledge
912 Tolstoy House, 15–17 Tolstoy Marg, Connaught Place,
New Delhi 110 001
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Simultaneously published in the UK

by Routledge
2 Park Square, Milton Park, Abingdon, OX14 4RN

Routledge is an imprint of the Taylor & Francis Group, an informa business

© 2013 Shahid Ahmed

Typeset by
Chitra Computers
U-129B, Ground Floor, Upadhyay Block,
Shakarpur, Delhi - 110 092

All rights reserved. No part of this book may be reproduced or utilised in

any form or by any electronic, mechanical or other means, now known
or hereafter invented, including photocopying and recording, or in any
information storage and retrieval system without permission in writing
from the publishers.

British Library Cataloguing-in-Publication Data

A catalogue record of this book is available from the British Library

ISBN 978-0-415-66213-0
 Contents
List of Tables vii
List of Figures xi
Acknowledgements xv
Foreign Direct Investment, Trade in Services and
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Economic Growth: An Introduction 1

Shahid Ahmed

SECTION I: FDI, TRADE AND ECONOMIC GROWTH

1. India–ASEAN Trade, FDI and Growth: Exploring
Challenges and Opportunities Post-global Financial
Crisis 25
Tran Van Hoa

2. FDI in Sensitive Sectors: The Case of the Retail

Sector in India 47
Tanu M. Goyal and Arpita Mukherjee

3. FDI and Precision Agriculture in India 81

Sarah Ahmed

4. Trade, Foreign Direct Investment and Economic

Growth Linkages in Selected South Asian Countries 101
Md. Saiful Islam and Syed Imran Ali Meerza

5. Estimating Country-specific Determinants of

Foreign Direct Investment Flows in India: Evidence
from VAR and the Innovation Accounting Model 113
Bikash Ranjan Mishra

6. Causality Between Trade, Foreign Direct Investment

and Economic Growth Under the Structural
Adjustment Programme in India: An Application
of the Toda Yamomoto Test 142
Harish

7. Foreign Direct Investment and Efficiency:

A Stochastic Frontier Analysis 166
Suman Sharma
 v i•Contents

8. Financial Decoupling of Emerging Asset Markets

from Japan and the US 186
Peter J. Morton

SECTION II: TRADE IN SERVICES

9. India’s Trade in Services with Select FTA and
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Non-FTA Partners: An Analysis of Comparative

Advantage 209
Nabeel A. Mancheri

10. Export Potential of India’s Higher Education Sector:

Identifying Opportunities and Constraints 235
Shahid Ahmed and Sushil Kumar
11. Changing Pattern of Country Competitiveness in
Trade in Computer and Information Services 260
Jayesh N. Desai

12. Optimal Pricing Policy of Kolkata–Agartala

Transit Route: Some Methodological Issues 281
Subir Kumar Sen, Sudakshina Gupta and Ishita Mukhopadhyay

SECTION III: VALUE CHAINS AND PRODUCTION NETWORKS

13. Integration of the Indian Machinery Sector
into Global Production Networks 303
Neha Gupta

14. Value Chain in the Light Engineering Sector of

Bangladesh: Challenges towards the Development
of Regional Linkages 336
Khondaker Golam Moazzem and Mehruna Islam Chowdhury

About the Editor 365

Notes on Contributors 366
Index 371
 List of Tables
1 Service Trade to GDP (Percentage) 9
2 Service Imports and Exports to Goods Imports and
Exports Respectively 11
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1.1 ASEAN–India Trade and Its Impact on India’s

Growth: EGT Modelling in Flexible Structural
Form, 1990–2008 37
2.1 Mode of Entry and Present Mode of Operation of
Selected Foreign Retailers 53
2.2 Sampling Frame 60
2.3 Top 10 Barriers Faced by Unorganised and
Organised Retailers 63
2.4 Percentage Distribution of Respondents as per their
Source of Purchase for Different Product Categories 71
3.1 Sectors Attracting Highest FDI Equity Inflows 94
3.2 Statement on Sector-wise FDI Inflows from
April 2000 to February 2011 95
4.1 DF/ADF Unit Root Tests for Bangladesh 106
4.2 DF/ADF Unit Root Tests for India 106
4.3 DF/ADF Unit Root Tests for Pakistan 106
4.4 Johansen and Juselious Cointegration Tests
Variables LGDP, LFDI and LEXP for Bangladesh 107
4.5 Johansen and Juselious Cointegration
Tests Variables LGDP, LFDI and LEXP for India 107
4.6 Johansen and Juselious Cointegration
Tests Variables LGDP, LFDI and LEXP for Pakistan 108
4.7 Granger Causality Test for Bangladesh 108
4.8 Granger Causality Test for India 109
4.9 Granger Causality Test for Pakistan 109
5.1 Unit Root Test of the Variables 130
5.2 VAR Lag Order Selection Criteria 132
5.3 Pair-wise Granger Causality Tests 133
5.4 Variance Decomposition of FDI 136
 v iii •
List of Tables

6.1 Unit Root Test on Levels 156

6.2 TodaYamamoto Test Based on SUR Estimation 157
7.1 Description of Variables 174
7.2 Maximum Likelihood Estimates of
Stochastic Production Frontier 176
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7.3 Tests of Hypothesis of Stochastic Production

Frontier 177
7.4 Maximum Likelihood Estimates of Stochastic
Production Frontier for Domestic Firms 178
7.5 Maximum Likelihood Estimates of Stochastic
Production Frontier with Inefficiency
Coefficients HHI and HHI Spillover 180
7.6 Maximum Likelihood Estimates of Stochastic
Production Frontier with Inefficiency Coefficients
RD and RD Spillover 181
8.1 Background Percentage Measures of Declining
US–Japanese Economic Dominance 190
8.2 Monthly Straits Times Market Index Log Change
Regressed on Neighbour Indices 196
8.3a Period Estimates of Relative Influence of S&P,
NK and Shanghai Indices on Straits Times 200
8.3b Multi-period Estimates of Relative Influence of
GSP, NK and Shanghai Indices on Hang Seng 201
9.1 India’s Total Trade in Services by
Services Category 215
9.2 India’s Service Trade with US, Japan,
Singapore and Australia 217
9.3 Revealed Comparative Advantage Indices in
Services for Selected Countries 220
9.4 Services Trade Intensity Indices between
India and the Selected Trading Partners 223
9.5 Intra-industry Trade Indices —
Selected Services Sectors 224
9.6 Trade Similarity Indices between India and the
Selected Partners, 2001–2006 225
 List of Tables •i x

10.1 Specific Commitments (India)—Higher

Education Services 239
10.2 Imports of Education Services of Selected
Countries in US$ Millions (Partner World) 240
10.3 International Flows of Mobile Students at the
Tertiary Level 242
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10.4 Top 10 Countries of Origin of Foreign Students,

1995–2008 243
10.5 Top 10 Originating Countries by International
Student Enrolment in India 244
10.6 Top 10 Destinations and Number of
Students Studying Abroad from India in 2009 245
10.7 India’s Imports of Education Services in
US$ Millions (Partner World) 245
10.8 Panel Regression Results (Random Effects) 250
10.9 Cost of the Study 252
10.10 Selected Barriers/Disincentives for Foreign
Students in India 253
10.11 Sponsors of Studies in India 254
10.12 Rating of Indian University Degrees in Comparison
to Universities in Developed Countries 254
10.13 Higher Education in India Compared to
South Asian Context 255
11.1 Ranking of Selected Countries in Export
Performance in CIS in 2000 and 2008 265
11.2 Ranking of Selected Countries in Import
Performance in CIS in 2000 and 2008 265
11.3 Ranking of Selected Countries in Relative Trade
Performance in CIS during 2000 and 2008 267
11.4 RCAs of Different Countries in Computer and
Information Services 271
11.5 Matrix of Competitive Interactions between
India and Other Countries in the Study 274
11.6 Change in World Market Share of Countries in
CIS during 2000–2008 275
 x•
List of Tables

11.7 Mapping India and Different Countries in the Study

for Competitive Performance during 2000–2008 276
13.1 Cost Structure in Two-dimensional Fragmentation 307
13.2 Values of GLIi for HS 84-92 316
13.3 Values of GLIIndia and GLIajIND for HS 84-92 317
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13.4 Simple Average Tariff Rates (India) 318

13.5 GL Index of IIT 320
13.6 Simple Average Tariff Rates (China, Malaysia and
Thailand) 327
14.1 Bangladesh’s Export of Different LEPs 341
14.2 Weighted GLI for LEPs (at two digit level) with
South Asian Countries in 2007 344
14.3 Weighted GL Index Values for LEPs (at two
digit level) in Selected ASEAN Countries 344
14.4 Revealed Comparative Advantage (RCA) of LEPs
(at two digit level) in 2007 345
14.5 Cost of Production of Razor Blades in a
Sample Firm 349
14.6 Export of Razor and Razor Blades from
Bangladesh 350
14.7 Sources of Import of Intermediate Products 351
14.8 Trade in Bicycles of Bangladesh with
South Asian Countries 353
14.9 LEPs in the Sensitive List of Sri Lanka 354
14.10 LEPs in the Sensitive List of Pakistan 355
14.11 Export Similarities between
South Asian Countries 356
14.12 Inflow of FDI in Bangladesh in Metal and
Machinery Industries 357
 List of Figures
1 Global FDI Inflows 5
2 Sectoral Distribution of FDI Projects, 2009–10 5
3 Global FDI Inflows (Top 20 Host Countries) 6
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1.1 India’s Top 10 Export Destination Trend, in

US$ Millions 27
1.2 India’s Top 10 Import Source Trend, in
US$ Millions 28
1.3 India’s Top 10 Export Destination Shares, 2008 28
1.4 India’s Top 10 Import Source Shares, 2008 29
1.5 India’s World Trade Partner Shares, 2008 29
1.6 ASEAN–India Trade Growth and Share 30
1.7 EGT Modelling Performance of India’s Growth:
Friedman–Kydland Criterion 38
1.8 EGT Modelling Performance of ASEAN–
India Trade: Friedman–Kydland Criterion 39
2.1 Share of Different Segments in the
Indian Retail Market, 2009 and 2014 49
2.2 Share of Different Segments in
Organised Retail, 2007 50
2.3 Average Salaries and Other Benefits across
Organised and Unorganised Retail Outlets 65
2.4 Percentage Distribution of Employees Receiving
Trainings and Outlets Imparting Training 66
2.5 Long-term and Short-term Job Prospects in the
Retail Sector 67
2.6 Distribution of Respondents Who Have Tried
Working in Organised Retail Outlets 68
2.7 Consumers’ Ranking of Various Parameters in
Organised Retail Outlets 72
2.8 Distribution of Respondents in Favour of
FDI by their Educational Qualification 74
5.1 Response to Cholesky One S.D. Innovations 135
 xii•List of Figures

5.2 Variance Decomposition of FDI 137

7.1 Indian Pharmaceutical Market 167
8.1 S&P vs Three Asian Stock Indices 187
8.2 Standardised Coefficients from Daily ST Closing
Values, Regressed on GSP and Nikkei,
by Years, 1991–2010 198
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8.3 Graph of Standardised Coefficients from ST and

MSFE Regressed on GSP—Daily Data by
Years, 1990–2010 198
9.1 Evolution of India’s Sectoral RCAs 222
9.2 India’s Trade Restrictive Index for Banking,
Insurance and Telecom 228
10.1 Originating Countries of Students 251
10.2 Source of Information about the Courses in Indian
Universities 254
11.1 Comparing Growth Rates of Trade in
CIS during 2000–2008 266
11.2 RCAs of Different Countries in Computer and
Information Services during 2000–2008 272
11.3 Change in WMS and Export Growth Rate and
Total Exports in CIS 277
13.1 Simple Version of Fragmentation Theory 305
13.2 Two-dimensional Fragmentation Theory 306
13.3 Shares of Machinery Goods in Total Exports to
and Total Imports from World in 2005 309
13.4 Shares of Machinery Goods in Total Exports to
and Total Imports from World in 2008/2009 310
13.5 Actual Trade of Machinery Goods in 2005 312
13.6 Actual Trade of Machinery Goods in 2008/2009 313
13.7 India’s Exports and Imports of Machinery Parts and
Components and Finished Goods, 1990–2009 314
13.8 India’s Share of Machinery Goods, 1990–2009 315
13.9/13.10 China’s Machinery Trade, 1992–2009 321
13.11/13.12 Malaysia’s Machinery Trade, 1990–2009 322
 List of Figures •x i i i

13.13/13.14 Thailand’s Machinery Trade, 1990–2009 323

14.1 Generic Value Chain of LES 339
14.2 Export of Bangladesh’s LEPs to the
World and South Asia, 2007 341
14.3 The Value Chain of Razors and Razor Blades 348
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14.4 Trade of Razors and Razor Blades with

the World 350
14.5 Value Chain of Bicycle Production 352
14.6 Trend in Export and Import of
Bangladeshi Bicycles to World 353
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 Acknowledgements
This book is a collection of essays on foreign direct investment, trade
in services and their links with economic growth and development.
Earlier versions of these essays were presented at seminars held
at various places including a two-day international conference
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on ‘Changing Structure of International Trade and Investment:

Implications for Growth and Development’ organised by the
Department of Economics, Jamia Millia Islamia, New Delhi, in
March 2011. I would like to place on record my gratitude to all those
organisations and people who have rendered their cooperation in
the conference arrangements and in editing the essays in the form
of a book. In particular, the following deserve special mention:
Shri Najeeb Jung, Vice Chancellor, Jamia Millia Islamia, for his
keen interest, encouragement and excellent leadership; all the
contributors to the present volume who have thoroughly revised
their research work and granted me permission to publish their
excellent essays; all my colleagues in the Department of Economics,
Jamia Millia Islamia, New Delhi, in particular Professor Khan
Masood Ahmad, Professor Shahid Ashraf, Professor Naushad Ali
Azad and Dr Mirza Alim Baig for their cooperation and support; the
Routledge team for their marvellous job in editing and getting the
book printed in the present form; my wife Saba and my daughters
Afsah and Samiya for their patience and support; and last but
not least, the Indian Council of Social Science Research (ICSSR),
New Delhi for their financial help and Centre for WTO Studies,
Indian Institute of Foreign Trade (IIFT), New Delhi for their
co-sponsorship.
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 Foreign Direct Investment, Trade in
Services and Economic Growth:
An Introduction

Shahid Ahmed
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F
oreign direct investment (FDI) is an important vehicle of
technology transfer from developed countries to developing
countries. At the same time, trade in services is not only
important for its own sake, it also facilitates the efficient production
of and trade in goods. Trade in services and FDI flows may have
a causal relationship to each other. In principle, causality can run
in either or both directions, from FDI inflows to services trade
and, conversely, from services trade to inward FDI. The impact of
trade in services and FDI on economic growth and development
has received prominence in the process of globalisation. However,
the significance of the impact varies across countries depending on
the level of human capital, structure and pattern of FDI and trade
in services, its relation with domestic investment, infrastructure,
economic stability and macroeconomic policies.
Foreign direct investment is defined as an investment
involving a long-term relationship and reflecting a lasting interest
and control of a resident entity in the source country (foreign
direct investor or parent firm) in the host country. It occurs with
the purchase of the physical assets or a significant amount of
ownership (stock) of a company in another country in order to gain
a measure of management control. In national and international
accounting standards, FDI is defined as involving an equity stake of
10 per cent or more. It is also often accomplished through merger
and acquisition activities or through international franchising.
In general, FDI has three components: equity capital,
intra-firm loans and reinvestment of retained earnings. Because
different countries have different recording practices relating to
these three components, some measurement problems arise. Not
all countries follow the 10 per cent mark for the definition of FDI.
Most countries do indeed report long-term intra-firm loans, but not
all countries report short-term loans. Most countries report rein-
vestment of retained earning only with a considerable lag. One
 2•Shahid Ahmed

implication of these measurement problems is that recorded FDI

inflows do not contemporaneously match FDI outflows.
Sampson and Snape (1985) have provided an operational
definition of trade in services that was largely incorporated in the
design of the General Agreement on Trade in Services (GATS) in the
World Trade Organisation (WTO). The Agreement categorises trade
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in services into four modes of supply. Mode 1, identified as cross-

border supply, applies when service suppliers resident in one country
provide services in another country without either supplier or buyer/
consumer moving to the physical location of the other. Mode 2,
identified as consumption abroad, applies to a consumer resident in
one country moving to the location of the supplier(s) to consume a
service. Mode 3, identified as commercial presence, covers services
provided by a service supplier of one country in the territory of any
other country, that is, foreign direct investment undertaken by a
service provider. Mode 4, identified as movement of natural persons,
refers to a process through which individuals (temporarily) move to
the country of the consumer to provide the service.
The linkages between FDI and services trade have been
increasingly consolidated with the globalisation of business
operations (Hardin and Holmes, 1997; Markusen et al., 1999;
and Dee, 2001). Dunning (1993) has explained that FDI opens
up an important channel for cross-border intra-firm trade in
value-adding activities. Firms usually engage in intra-firm trade
because they find it more efficient to do business within firms
than externally through the market. FDI has also been used to
integrate production vertically and horizontally as the corporate
strategy to promote the internationalisation of activities.
Porter’s (1985) generic value chain model helps to explain the
increasing importance and changing pattern of inter- and intra-
firm investment and trade relationships. It is unusual that one
single firm performs all the core activities (e.g., research and
development, production, marketing, delivery, and provision of
after-sale services) and supporting activities (e.g., procurement
of inputs, technology, human resources, and other infrastructure,
like management and finance) by itself. Some of these activities
can readily be performed cheaper or better by suppliers located
elsewhere, which can lead to the determination of cross-
border transaction flows in intermediate goods and services by
multinational hierarchies (Dunning, 1993).
 Introduction •3

Worldwide Flow of FDI

The benefits of FDI are well-established both theoretically and
empirically. Literature shows that FDI can provide a firm with new
markets and marketing channels, cheaper production facilities,
access to new technology, products, skills and financing. It may take
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many forms, such as a direct acquisition of foreign firms, construction

of a facility, or investment in a joint venture or strategic alliance with
a local firm, and licensing of intellectual property. Faster innovations
in information and communication technology (ICT) have reduced
costs and have made the management of foreign investments far
easier than in the past. Significant changes have been made by
many countries in their trade and investment policies in the past
decade which include trade policy and tariff liberalisation, easing
of restrictions on FDI and acquisition policies, and the deregulation
and privatisation of many industries. These changes have probably
been the most significant catalyst for FDI’s expanded role.
Foreign direct investment inflows stimulate growth and
trade through backward and forward linkages. It is considered to be
the most attractive type of capital flow for developing economies.
Distinguishing characteristics of FDI are its stability and ease of
service relative to commercial debt or portfolio investment. The
traditional unidirectional flow of FDI from developed countries to
developing countries has changed in recent times. Foreign direct
investment outflows from developing to developed economies in
the recent period have increased at an alarming rate. Companies in
developed countries are taking note of the potential of developing
economies’ markets while companies of developing economies are
also constantly looking for synergistic acquisitions abroad.
Established theories of FDI suggest that competitive advantage
in the form of ownership, location and internationalisation, allows
firms to acquire monopolistic and oligopolistic power in the market
and expand their businesses internationally through investments,
mergers and acquisitions (Dunning, 2000). According to Caves
(1990) acquisition of a foreign competitor enables the acquirer to
bring a more diverse stock of specific assets under its control and
therefore seize more opportunities. Various studies have argued
that multinational companies (MNCs) internationalise businesses
mainly to acquire intangible assets and complementary resources
which they do not possess and which are essential to develop a
 4•Shahid Ahmed

competitive advantage for survival in more competitive environments

(Wang and Boateng, 2007; Aulakh, 2007).
Unrestricted capital flows may also offer several advan-
tages, as noted by Feldstein (2000). First, international flows
reduce the risk faced by owners of capital by allowing them to
diversify their lending and investment. Second, the global inte-
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gration of capital markets can contribute to the spread of best

practices in corporate governance, accounting standards and legal
traditions. Third, the global mobility of capital limits the ability of
governments to pursue bad policies.
Presently, there are a variety of barriers to free flows
of FDI in both developed and developing countries. Brown and
Stern (2001) identify three main categories of these barriers —
restrictions on market access, ownership and control restrictions
and operational restrictions. Examples of market access restric-
tions include outright bans on FDI, restrictions on the legal form
of entry, minimum capital requirements, screening and approval,
and conditions on location and further investment. Restrictions on
ownership include the need for a local partner, mandatory trans-
fer of ownership to locals after a specific period, and government-
appointed board members. Governments may also put restric-
tions on the operations of foreign-owned companies by requiring
them to export a certain percentage of output, meet local content
requirements and restrict the repatriation of profits.
Despite the variety of restrictions, FDI grew at twice the
rate of global output in the 1950s and 1960s (Dickens, 1998).
However, there were controversies in the 1970s around the powers
and motivations of MNCs, profit repatriation and transfer pricing
issues, as noted by dependency theorists such as Santos (1970) and
an array of other scholars like Lieten (2001). World trends of FDI
have significantly changed since the 1980s. Total FDI stocks in the
world, in fact, increased more than 25 times in the last three decades
(i.e., from US$ 700 billion in 1980 to US$ 17.7 trillion in 2009).
The United States has maintained the first rank in both inward and
outward FDI flows. The top 10 ranked countries in 2009 in terms of
inward FDI flows were US, China, France, Hong Kong, UK, Russia,
Germany, Saudi Arabia, India, and Belgium. For the same year,
the top 10 in terms of outward FDI flows were US, France, Japan,
Germany, Hong Kong, China, Russia, Italy, Canada, and Norway.
Global FDI flows rose moderately to $1.24 trillion in 2010,
but were still 15 per cent below their pre-crisis average (Figure 1).
 Introduction •5

This is in contrast to global industrial output and trade, which

were back to pre-crisis levels (World Investment Report [WIR],
2011). In 2010, global FDI recovered due to an increase in FDI
flows to developing countries by 10 per cent, however, FDI flows
to developed countries contracted further in 2010 (7 per cent
compared with 2009). Statistics indicate that the value and share
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of the primary and services sector declined (Figure 2). Compared

with the pre-crisis level (2005–7), the picture is quite different. While
the primary sector has recovered, services are still less than half, and

Figure 1: Global FDI Inflows

1.971
1.744
~37%
1.472
1.185 ~15% 1.244

2005–2007 2007 2008 2009 2010

Average
Source: WIR, 2011.

Figure 2: Sectoral Distribution of FDI Projects, 2009–10

(Dollars in billions and distribution in percentage)

600
554
2009 2010
500
449
392
400 361
338
300 254
200
30% 22% 37% 48% 33% 30%
100

0
Primary Manufacturing Services
Source: WIR, 2011.
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Figure 3: Global FDI Inflows (Top 20 Host Countries)

United States (1) 228

153
China (2) 106
95
Hong Kong, China (4) 69
52
Belgium (17) 62
24
48
6•Shahid Ahmed

Brazil (15)
26
Germany (6) 46
38
United Kingdom (3) 46
71
Russian Federation (7) 41
36
Singapore (22) 39
15
France(10) 34
34
Australia (16) 32
26
Saudi Arabia (11) 28
32
Ireland (14) 26
26
India (8) 25
36
Span (30) 25
9
Canada (18) 23
21
Luxembourg (12) 20
30
Mexico (21) 19
15 2010
Chile (26) 15 2009
13
Indonesia (43) 13
5
0 20 40 60 80 100 120 140

Source: WIR, 2011.

 Introduction •7

manufacturing is 10 per cent below its pre-crisis levels. Foreign

direct investment flows also reveal uneven regional distribution.
Flows to Africa, least developed countries, landlocked developing
countries and small island developing states all fell, as did flows to
South Asia. At the same time, major emerging regions, such as East
and South East Asia and Latin America experienced strong growth
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in FDI inflows.
It is to be noted that the developed countries accounted
for less than half of global FDI flows in 2010, with shares falling
from 57 per cent in 2008 to 51 per cent in 2009 and 47 per cent in
2010. By contrast, the share of developing and transition countries
climbed from 43 per cent in 2008 to 53 per cent in 2010. The Latin
American and Caribbean region attracted 10 per cent of global FDI
in 2010. In 2010, the main FDI recipients among the developed
countries were the United States, France, Belgium, and the United
Kingdom. The largest recipients among the developing countries
were the BRIC countries (Brazil, the Russian Federation, India and
China) (Figure 3).

Trade in Services
Given the changing dynamics of economic development over time,
the services sector has transformed from a trivial entity to a non-
trivial entity in developing economies. The sector is important
from many perspectives, including employment shares, cost shares
for industry and sector share of overall FDI. Francois and Rein-
ert (1996) document the role of services in economies at differing
levels of development and note that the importance of services in
relative terms increases as countries become richer. Despite the
expanding importance of services, services have not figured promi-
nently in the economic growth and development literature except
in a few path-breaking studies such as those by Baumol (1967),
Fuchs (1968) and Hill (1977). More attention has been devoted to
services since the Uruguay round of the WTO. One reason for this
was the emergence of services on the international policy agenda,
largely as the result of US proposals to negotiate multilateral rules
on policies affecting trade in services.
The services sector is not homogeneous but very hetero-
geneous in nature, and plays a critical role in a wide range of eco-
nomic activities. Services perform many functions in relation to
 8•Shahid Ahmed

overall economic growth and development. However, exchange of

services requires the proximity of supplier and consumer. Service
transactions, to be feasible, imply that ‘trade’ will often involve a
mix of cross-border transactions and the local presence of suppli-
ers. Hence, the regulatory regimes pertaining to the (temporary)
movement of people (visa restrictions, economic needs tests) and
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the longer-term establishment of service suppliers (FDI policies)

are important determinants of the feasibility of trade in services.
All these factors determine the market structure for service indus-
tries. The proximity requirements also imply the absence of scale
economies along with product differentiation. These factors create
differences between trade in goods and services. One difference is
that goods do not fulfill the type of intermediation role many serv-
ices do or generate the types of network externalities some service
industries do.
An important economic characteristic of many services is
their ‘facilitating’ role. Services are essential inputs into the pro-
duction of virtually all products. As argued by Francois (1990), the
growth of intermediation services is an important determinant of
overall economic growth and development. Much of this interme-
diation activity facilitates transactions through space (transport,
telecom) or time (financial services) (Melvin, 1989). Recent studies
such as Arnold et al. (2007, 2008, and 2010) and Fernandes and
Paunov (2008) analyse the effects of allowing foreign service pro-
viders greater access to services industries on the productivity of
manufacturing industries. The results show a positive relationship
between FDI in services and the performance of domestic firms in
services and in manufacturing. Francois and Hoekman (2010) and
Mattoo, Stern and Zannini (2008) highlight the fact that the effi-
cient services sector has a powerful influence on economic growth.
The productivity and competitiveness of both manufacturing and
agriculture increasingly depend on access to low cost and high
quality producer services such as telecommunications, transport,
finance, and distribution. Thus, when liberalised and made more
efficient, services have a strong effect on the competitiveness of an
entire economy.
Long considered as non-tradable and thus ignored in trade
agreements and statistics, though services have become important
in international trade in recent decades. Services trade is the fastest
growing part of world trade where developing countries are playing
 Introduction •9

a significant role. World exports of commercial services rose by 8

per cent, from US$ 3.4 trillion in 2009 to US$ 3.7 trillion in 2010.
Transportation was the fastest growing component of commercial
services exports in 2010, with an increase of 14 per cent to US$ 782.8
billion (World Trade Report [WTR], 2011). The top five importers
in world commercial services in 2009 as per WTO data were USA
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(10.5 per cent), Germany (8.1 per cent), UK (5.1 per cent), China
(5.0 per cent) and Japan (4.7 per cent). The United States exported
$515 billion in commercial services in 2010, or 14 per cent of the
global total, making it the world’s largest exporter. In 2010, the
top four exporters were Germany (6 per cent), the United Kingdom
(6 per cent), China (5 per cent) and France (4 per cent). India was
the ninth largest exporter of services with a share of 2.7 per cent
in 2008 and moved to 12th position with a share of 2.5 per cent in
2009 largely due to the global financial crisis (ibid.).
Table 1 shows the increasing importance of service trade
in gross domestic product (GDP). At the world level, service trade
was 7.6 per cent to world GDP in 1980 which remained stagnant
up to 1990. It slowly reached up to 9.3 per cent to world GDP in
2000. In 2010, service trade to GDP ratio was 11.68 per cent. These
statistics indicate that the growth rate of global trade in services
was higher than the growth rate of GDP. However, growth rate of
trade in services varies across regions and countries. The trade in
services to GDP ratio has gone up from 6.72 to 10.48 per cent in
East Asia and the Pacific, from 10.53 to 18.21 per cent in EU, from
7.68 to 12.97 per cent in high-income (Organisation for Economic
Cooperation and Development [OECD] and non-OECD) countries,
from 9.40 to 14.08 per cent in low-income countries, from 3.94 to
13.01 per cent in South Asia and from 11.08 to 12.92 per cent in
Sub-Saharan Africa during 1980–2010.

Table 1: Service Trade to GDP (in Percentage)

East Sub-
High Low South
Year Asia & EU Saharan World
income income Asia
Pacific Africa
1980 6.72 10.53 7.68 9.40 3.94 11.08 7.60
1985 5.26 11.07 6.92 8.39 3.81 9.70 6.71
1986 4.44 10.08 6.69 8.04 3.60 9.15 6.52
1987 4.75 9.96 6.91 9.14 3.59 8.49 6.77
(continued)
 10•Shahid Ahmed

(continued)
1988 4.97 9.91 6.92 9.05 3.73 8.74 6.82
1989 5.53 10.23 7.19 9.30 4.14 9.11 7.07
1990 5.88 10.56 7.71 9.75 4.23 10.95 7.58
1991 5.63 10.50 7.72 9.37 4.96 10.57 7.65
1992 5.84 11.12 7.93 10.12 5.70 10.76 7.93
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1993 5.81 11.56 7.79 11.98 5.22 12.06 7.86

1994 6.07 11.34 7.71 13.26 5.43 12.12 7.77
1995 6.51 11.52 8.00 13.60 5.79 12.60 8.07
1996 7.36 11.84 8.44 12.00 5.67 12.88 8.44
1997 7.91 12.57 8.75 12.14 5.87 12.66 8.75
1998 8.41 13.21 9.21 12.09 6.50 13.68 9.08
1999 7.83 13.54 9.09 12.45 7.09 13.36 9.02
2000 7.96 14.98 9.43 10.58 7.56 12.59 aa9.30
2001 8.42 15.33 9.53 11.00 7.70 13.88 9.43
2002 8.91 15.62 9.92 10.99 7.88 14.05 9.83
2003 8.97 15.26 10.13 10.88 8.16 13.31 10.01
2004 9.91 15.64 10.80 12.41 9.94 12.89 10.65
2005 10.27 16.32 11.21 13.06 11.51 12.47 10.93
2006 10.79 17.07 11.84 13.59 12.69 13.22 11.35
2007 11.55 17.71 12.77 14.03 12.10 14.05 11.99
2008 11.55 18.26 13.37 14.45 14.71 14.58 12.37
2009 10.08 17.67 12.62 12.84 11.68 13.46 11.60
2010 10.48 18.21 12.97 14.08 13.01 12.92 11.68
Source: World Trade Indicators, 2011, World Bank.

Table 2 shows the relative importance of service trade

relative to merchandise trade for major developed, developing
and least developed countries. If we compare the ratio of service
imports and exports to goods imports and exports respectively, it
is revealed that both imports and exports of services relative to
merchandise imports and exports has gone up during 2000–2009.
However, growth rate of trade in services varies across countries.
The ratio of services imports to merchandise imports has gone up
from 24.08 to 27.08 per cent in Austria, from 29.83 to 36.8 per
cent in Brazil, from 18.36 to 24.5 per cent in Canada, from 29.22
to 34 per cent in UK, from 17.34 to 23 per cent in the US and from
57.04 to 167.15 per cent in Ireland during 2000–2009. At the same
time, this ratio remains constant for major emerging economies
such as China, India and South Africa. The ratio of services exports
 Introduction •1 1

Table 2: Service Imports and Exports to Goods Imports and

Exports Respectively (in Percentage)

Part- Imports Exports

Reporter
ner 2000 2005 2008 2009 2000 2005 2008 2009
Austria World 24.08 25.65 24.52 27.08 36.1 36.06 37.16 41.8
Armenia World 22.94 31.39 23.7 27.01 46.56 43.88 61.13 86.19
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Brazil World 29.83 33.09 27.22 36.8 17.23 13.54 15.38 18.12
Bulgaria World 25.58 18.78 16.1 21.59 44.98 37.76 35.26 41.55
Canada World 18.36 20.91 21.67 24.5 14.5 15.47 14.84 18.64
Chile World 28.89 23.69 18.83 22.58 22.42 17.29 16.23 15.83
China World 16.01 12.7 14.03 15.81 12.21 9.76 10.28 10.78
Cyprus World 30.11 42.42 46.00 52.14 771.79 1272.40 1500.05 1484.8
Denmark World 47.25 49.89 57.5 62.2 48.74 52.76 62.98 59.73
Finland World 24.83 30.28 33.13 42.27 13.57 26.06 33.17 43.91
France World 20 22.47 20.45 23.56 27.28 28.17 28.2 30.94
Germany World 28.21 27.16 24.22 27.15 15.74 17.09 17.92 20.52
Greece World 38.26 26.85 27.92 29.74 178.21 196.62 196.94 187.75
Indonesia World 46.66 38.21 21.85 28.8 8.39 15.09 11.13 11.83
Ireland World 57.04 101.7 131.08 167.15 22.13 54.52 78.83 79.54
Italy World 23.24 23.39 23.38 27.28 23.52 23.98 21.62 24.08
Jamaica World 44.57 35.26 27.96 37.13 154.92 153.82 114.62 201.41
Jordan World 42.91 24.32 24.48 27.05 126.82 54.54 57.61 71.56
Latvia World 21.81 17.95 20.26 24.26 62.62 41.27 49.07 53.4
Luxembourg World 128.21 137.75 158.32 191.3 257.75 318.4 394.61 473.73
Madagascar World 52.7 36.5 38.18 33.52 42.24 59.56 54.31 54.06
Maldives World 28.22 28.60 25.26 29.63 457.35 309.79 860.45 1035.68
Malta World 22.23 31.17 45.43 53.19 44.84 82.76 128.81 154.16
Mauritius World 35.69 37.91 41.14 42.98 71.89 75.47 105.86 126.23
India World 27.53 23.17 17.79 20.18 38.41 52.4 57.3 51.25
South Africa World 21.82 22.06 19.19 22.96 19.25 24.03 17.26 22.15
Spain World 21.7 23.17 25.07 30.4 46.37 49.19 51.46 55.06
Sweden World 32.9 31.76 32.16 38.06 24.85 33.09 38.84 45.27
Thailand World 24.93 22.89 25.93 28.46 20.1 18.29 18.97 19.8
U.K. World 29.22 31.58 31.99 33.95 42.42 54.05 62.95 66.23
U.S. World 17.34 17.39 18.23 23.02 39.84 45.80 45.44 53.17

Source: Author’s calculations from UN COMTRADE Data, extracted through World Integrated
Trade Solution (WITS), available at [Link] and UN Service Trade, United
Nations Service Trade Statistics, available at [Link]
aspx (accessed 6 July 2012).

to merchandise exports has gone up from 36 to 42 per cent in

Austria, from 17 to 18 per cent in Brazil, from 14.5 to 18.6 per
cent in Canada, from 42.42 to 66.23 per cent in UK, from 39.84
 12•Shahid Ahmed

to 53.17 per cent in the US, from 38.41 to 51.25 per cent in India
and from 22.13 to 79.54 per cent in Ireland during 2000–2009.
These statistics also indicate that some of the economies such as
Cyprus, Maldives, Greece, Mauritius, Luxembourg, Jamaica, etc.,
are highly dependent on service trade. An inference may also be
drawn that the growth rate of global trade in services was higher
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than the growth rate of merchandise trade.

Value Chain and Productive Network

The new industrial and technological revolution has brought
about a significant, fast and extensive transformation of society
and economy in recent decades. Firms have reoriented their global
strategies towards FDI and service trade, the production value
chain or production network to optimise their long-term goals. A
value chain is the sequence of production, or value-adding activities
leading to and supporting end users of a particular product. It is, in
other words, the chain of activities required to bring a product from
its conception to its final consumption. Overlapping names and
concepts have been given to this sequence of activities (McCormick
and Schmitz, 2001). An important distinction can be made by
contrasting the various ‘chains’ to the various ‘networks’, where a
‘chain’ maps the vertical sequence of events leading to the delivery,
consumption and maintenance of a particular good and service,
while a ‘network’ maps both the vertical and horizontal linkages
between economic actors.
Value chains may be national, international or global,
depending on the location of the various processes comprising
them. In a national chain, all processes from design to distribu-
tion take place within national boundaries. In many chains, the
processes spill over beyond national borders and become regional,
international or even global. In global value chains, the differ-
ent processes of design, supply, production, etc., take place in dif-
ferent parts of the world (Gereffi and Kaplinsky, 2001). Gereffi
(1994, 2001) is credited with identifying two main types of value
chains: buyer-driven and producer-driven. In the buyer-driven
value chains, the buyer at the apex of the chain plays the criti-
cal governing role. Labour-intensive industries common in least
industrialised countries are often buyer-driven. Examples include
 Introduction •1 3

garments, processed fruits and horticultural products (Gereffi

and Kaplinsky, 2001; Dolan and Tewari, 2001). In the producer-
driven chains, producers with critical technology play the main
role of coordinating the various links and take the responsibility of
checking the efficiency of their suppliers and customers. Producer-
driven chains often have significant foreign direct investment,
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and are more often capital- and technology-intensive industries

(Gereffi, 2001).
The linkages between FDI and services trade have been
progressively consolidated with the globalisation of business
operations of MNCs (Markusen et al., 1999; and Dee, 2001).
Dunning (1993) has explained that FDI opens up an important
channel for cross-border intra-firm trade in value-adding activities.
Firms engage in intra-firm trade because it is more efficient to
do business within firms than externally through the market.
Further, MNCs form networks to promote the internationalisation
of activities as business strategy. This is supported by FDI that
integrates production vertically and horizontally. Porter’s (1985)
generic value chain model helps to explain the increasing importance
and changing pattern of inter- and intra-firm investment and trade
relationships. The value chain analysis provides an important
construct that facilitates the understanding of the distribution of
returns from the different activities of the chain (Kaplinsky and
Morris, 2001).
The changes in the international economic integration
process have been underway for decades, facilitated by more
open economic policies and trade liberalisation in a growing
number of countries. One factor for the speeding up of the whole
globalisation process is the rapid emergence of global value chains.
The entire process of producing goods, from raw materials to
finished product, has increasingly been ‘sliced’ and each process
can now be carried out wherever the necessary skills and materials
are available at competitive cost. The process of the value chain is
driven by companies’ desire to both increase efficiency as growing
competition in domestic and international markets forces firms to
become more efficient and lower costs, as well as to enter new
emerging markets and gain access to strategic assets that can
help tap into foreign knowledge. Technical advances, notably in
transport and communication, have lowered costs and also fostered
globalisation of value chains and production networks.
 14•Shahid Ahmed

About the Book

Foreign direct investment and services trade have played a
significant role in determining the growth of developing countries.
Both have assumed added significance from a broader global
policy perspective in the aftermath of the 2008 financial crisis.
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They are continuing to face high tariffs, trade barriers and other
varieties of non-tariff barriers which act as a brake on growth
and development. A further lowering of trade barriers is vital if
developing countries are to participate in global production chains
to their full potential. It is expected that the FDI flows will increase
if trade barriers are reduced and trade will increase if FDI flows
increase. Causality depends on a variety of factors.
Many developing countries have adopted outward looking
strategies to promote economic growth. Trade in services and
FDI have been duly recognised as important economic growth
enhancing factors in the theoretical and empirical literature. In
recent times, major structural changes in international trade and
investment patterns are visible, namely, (i) merchandise trade is
declining while trade in services is increasing; (ii) the gravity of
international trade and investment activity is shifting from the
traditionally developed world to the emerging economies; and (iii)
there is a surge in merger and acquisition deals, emerging MNCs
and the shifting of FDI towards services sectors. These structural
changes are currently part of academic and policy discussions in a
variety of forms and contexts.
In the light of these facts, this volume aims to focus on
FDI and related issues, trade in services production value chain
and their links with economic growth and development. There is
a need for both theoretical and empirical research on these issues
so that new policy inputs can be provided to concerned parties
to harmonise investment and trade policy-making at the regional
and multilateral level. To examine these issues on objective basis,
this volume contains three sections: first about FDI, Trade and
Economic Growth; second about Trade in Services, and third about
Value Chains and Production Networks. It is against this backdrop
that the Department of Economics, Jamia Millia Islamia, organised
a two-day international conference on ‘Changing Structure of
International Trade and Investment: Implications for Growth and
Development’. How far we have succeeded is reflected through the
 Introduction •1 5

pages of this volume, which is a collection of the selected revised

papers on FDI, trade in services and value chains (also the themes
of the three sections of this volume) presented at the conference.
Section I consists of eight chapters that discuss various
investment inflows and their linkages. The focus of this section
is on the linkages between FDI, trade and economic growth. At
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present, there is no universally accepted model of such linkages.

Hence, confusion still prevails over the key factors capable of
explaining a country’s propensity to attract investment; it is not yet
clear how the country-specific characteristics are likely to influence
the determinants of, and motivations for, FDI inflows. There is
always a debate over the optimal strategy for FDI use as a source
for economic growth. Similarly, the direction of causality between
trade and FDI is still one of the debated and unsettled issues in
economic literature. The present section attempts to bridge the gap
in the literature on these dimensions.
Chapter 1 provides credible evidence-based policy options
for improved India–ASEAN economic, trade and external relations
in the context of India’s ‘Look East’ policy, ‘economic diplomacy’,
regional integration and post-global financial crisis policies. It
first reviews recent historical developments in these relations
and analyses their major priorities and pertinent trends. It then
develops a new endogenous growth and trade model to empirically
determine India–ASEAN growth–trade causality and to provide
credible economic, trade, investment and regional integration
policy options under several plausible regional and global scenarios
of future developments.
Chapter 2 of this section presents an overview of the retail
sector in India, analyses the present FDI policy and makes policy
recommendations. The chapter is based on a pan-India survey of
around 1,000 stakeholders. The study found that the present FDI
restriction is not an entry ban and the views on FDI vary across
different stakeholders. It concludes that there is a need for a
transparent FDI policy, streamlining of existing retail regulations
and identification of a nodal agency for governing this sector. It
recommends that FDI should be allowed in multi-brand retail in a
phased manner.
Chapter 3 investigates FDI inflows in the agriculture sector,
particularly in precision agriculture. This chapter emphasises the
need of concentrated efforts to modernise the agriculture sector
 16•Shahid Ahmed

through FDI in precision agriculture technology and the education

of the farmers in the use of this technology. The adoption rate of
precision agriculture will increase in the future with the increasing
number of graduates from agricultural universities and farm
managers. This chapter attempts to explore these aspects and the
role of FDI in achieving these goals.
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Chapter 4 explains trade, foreign direct investment and

economic growth linkages in selected South Asian countries. The
main objective of this chapter is to test the export-led and FDI-led
growth hypotheses for three selected South Asian countries: Bang-
ladesh, India and Pakistan. This chapter investigates the relation-
ship between exports, FDI and GDP of these three countries for the
period 1973–2008. The results from the comparative analysis for
causality relationship among the variables are not the same for all
countries since each country is at a different level of development.
Chapter 5 is an attempt to bridge the gap in the literature
regarding the investigation of the country-specific factors that
influence FDI flows into India using quarterly time series data over
the period 1996–2009. The results indicate that India’s domestic
product, domestic investment, export performance, and trade
openness positively contribute to further inflows of FDI.
Chapter 6 investigates the relationship between trade,
FDI and economic growth in India over the period 1970–2009
with emphasis on and a comparison between the periods before
and after the adoption of the structural adjustment programme.
The results show that there is a causal relationship between the
variables under study. Economic growth, trade and FDI appear to
be mutually reinforcing under the open-door policy.
Chapter 7 uses a stochastic translog production frontier to
test for the spillover hypothesis that ‘FDI contributes to productivity
growth in the Indian drugs and pharmaceutical industry’. Further,
the study examines the effect of competition and R&D on
productivity. The results show that there exists a positive spillover
from the presence of foreign-owned firms and higher competition
facilitates spillovers from a foreign presence in the industry. It also
highlights the fact that firms with R&D expenditure receive more
productivity spillovers than those without.
Chapter 8 discusses the decoupling of emerging market
economic events from those in the United States and Japan. The
recent financial crisis shows that a more multi-polar system need
 Introduction •1 7

not lead to any diversification-induced portfolio smoothing effects

for global economic activity. A decoupling model that operates by
magnifying the effects of foreign-originated shocks rather than
offsetting them would have many drawbacks, and might occur
if, along with the reduction in its relative size, the US economy
increases its ability to transmit disturbances to other economies.
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The chapter considers how this could come about, and examines
two decades of stock index data for evidence that this has occurred.
Section II of the book discusses issues related to trade in
services. In the changing dynamics of economic development, the
services sector has become significant for its contribution to GDP
and trade in developing economies. For instance, the contribution
of the service sector to GDP is around 76.8 per cent in the US, 57.2
per cent in India, 43 per cent in China, 73.8 per cent in Japan,
53.4 per cent in Pakistan, 71.3 per cent in Germany, 60 per cent in
Russia, and 79.8 per cent in France. This section consists of four
chapters discussing various aspect of trade in services. Chapter
9 of this section focusses on the features of trade in services of
India, and the importance of services in bilateral trade of India
with the free trade agreement (FTA) and non-FTA partners. The
chapter tries to analyse the impact of FTAs on the service trade of
India vis-à-vis non-FTA partners. It subsequently analyses technical
barriers to service trade and other restrictions imposed by India on
services and also looks into the comparative advantages of services
in India’s foreign trade.
Chapter 10 tries to identify the export potential of India’s
higher education services. This research draws its inference from
secondary and primary data analysis and uses an econometric
model to identify robust factors in the determination of the choice
of India as service provider in the education sector. A field survey
has been undertaken in this context which identifies opportunities
and barriers to movement of foreign students to India. The
participants in this survey are foreign students registered in Indian
universities. The present research identifies the relative education
cost in India, scholarships from India, own preference and safety
along with better marketability of degrees in their job market,
as the main factors behind the attraction towards the Indian
education sector. It concludes that India has potential in trade in
education services if policy makers strategise appropriately in the
light of global education needs.
 18•Shahid Ahmed

Chapter 11 in this section studies the competitiveness of

different countries in trade in computer and information services
(CIS). In order to investigate competitiveness, 12 countries are
selected based on their size in trade in services and rankings in A.
T. Kearney’s Services Location Index. This chapter indicates that the
emergence of India in the global service trade arena is due to the
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changing structure of country competitiveness at the world level.

Chapter 12 investigates the pricing policy of the transhipment route
for India to move cargo through Bangladesh from Kolkata port to the
capital city of Tripura, Agartala. Most of the cargo originates from
Kolkata and terminates at Guwahati and is distributed to various
destinations of the northeastern states. This chapter tries to inves-
tigate the pricing policy of such a transhipment route for India in
terms of a Bertrand type model with non-homogeneous type cargo
movement where the unit price of cargo transhipment is taken as a
proxy for such a transhipment route.
Section III consists of two papers covering issues related
to the value chain and production networks. The spread of
multinational companies through their global and regional value
chains is at the forefront of the current phase of globalisation.
Through their networks, MNCs structure national business systems
and influence public policy. Participation in the global value chain
for industrial enterprises of least developed countries (LDCs) has
suffered due to the prevalence of constraints at domestic and
regional levels. In this regard, Chapter 13 aims to assess the extent
of integration of India’s machinery sector (HS 84-92) into global
production networks (GPNs) and compares it with the successful
cases of China, Malaysia and Thailand. In this chapter, thirty-four
countries are graphically plotted for 2005 and 2008–9, starting
with the one with the highest export shares of intermediate
goods. Among 34 countries, India was at the 24th position which
indicates its low participation in GPNs. Its intra-industry trade is
comparatively very low, as measured by the Grubel-Lloyd Index,
with more imports of finished goods. Its machinery industry is
witnessing rising trade owing to various policies/measures, but
still has less participation in GPNs. Specific policy suggestions
include developing machinery hubs, promoting export-oriented
FDI, expanding suppliers’ markets, lowering tariff rates, and
increasing role as assemblers.
 Introduction •1 9

Chapter 14 in this section puts forward a comparative

analysis of two subsectors (blades and bicycles) of the light engi-
neering sector of Bangladesh and has tried to identify differences
between their competitiveness and the extent of participation in
the global value chain and explore possibilities to develop regional
value chains on these products. At the regional level, the inclu-
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sion of light engineering products in the sensitive lists, similarity

of products produced in the South Asian countries, insignificant
inflow of intra-regional FDI and various kinds of non-tariff barriers
are the major reasons adversely affecting the development of value
chains of light engineering products. This chapter argues for the
development of horizontal and vertical linkages by excluding the
light engineering products from the individual countries’ sensitive
lists, simplifying procedures for trading goods within the region,
development of diversified product-base and increased investment
for development of trade facilitation measures within the region.
In summary, this volume examines the opportunities
and challenges in trade in services for developing economies in
a globalised and integrated world. It explores various channels
through which trade in services and FDI affect growth and
development processes. We are conscious that many theoretical,
empirical and policy issues could not find a place in this volume.
With all humility, we do accept the primacy of these issues.
Whatever we have presented is expected to be a useful addition
to the literature on the dynamics of FDI and trade in services.
This book discusses issues related to India, and other developing
countries and provides useful insights. It is hoped that it will serve,
in some way, as a fruitful guide to the formulation of FDI, trade
and economic policies for the benefit of developing and emerging
economies. The book is based on the results derived from objective
methodologies based on latest data. It is expected to contribute to
and enhance the understanding of students, researchers and policy
makers involved in teaching and research in FDI and international
trade in services. It is also expected that research methodologies
and databases used in the various chapters will be useful reference
for future researchers.

Y
 20•Shahid Ahmed

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Downloaded by [University of Toronto] at 13:44 15 January 2017

Section I

FDI, Trade and Economic Growth

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 1
India–ASEAN Trade, FDI and Growth:
Exploring Challenges and Opportunities
Post-global Financial Crisis
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Tran Van Hoa

T
he recent economic (and geopolitical) rise of China and India
in the world has attracted extensive international attention,
debate and policy re-evaluation. As a result, in Asia, a focus
on India and the ASEAN and their relations has become a major
regional research and policy study. To partly underscore this interest,
the world leaders at the First East Asia Summit in Kuala Lumpur,
Malaysia, on 14 December 2005, endorsed high-level studies and
dialogues on an enlarged ASEAN free trade agreement (AFTA) to
promote further regional integration for mutual economic and
political benefits between the ASEAN and the world’s other trading
blocs (e.g., India, the US, the EU, East Asia, Oceania, and Russia).
The endorsement is consistent with India’s post-1991 reforms,
the ‘Look East’ policy, ‘economic diplomacy’ and recent energy
diplomacy (DFAT, 2011). While these policies have been helped
by regional reform and cooperation, they have also been hindered
to some extent by geopolitical regional developments, natural
disasters and the global financial crisis (GFC).
This chapter is, in addition to its descriptive analysis, an
evidence-based contribution to the study of this ASEAN–India trade,
economic and regional integration areas and their significant and
credible policy implications. It adapts a new endogenous growth-
trade theory and improved flexible modelling policy approach that
has won international acclaim (see Tran, 2002a, 2004, 2005, 2007c,
2008, 2010) to construct a causality model of ASEAN–India trade,
growth and political economy. Using historical harmonised data
from the Reserve Bank of India (RBI) and the Asian Development
Bank (ADB) and advanced econometric estimation methods,
the chapter provides efficient and robust empirical findings on
the determinants of the ASEAN–India trade in goods, FDI and
services, and their linkage to economic growth for more credible
policy analysis in the framework of Friedman (1953) and Kydland
 26•Tran Van Hoa

(2006). Implications of the findings for ASEAN–India relations in

the context of challenges and opportunities in the economic and
trade policy of an enlarged AFTA or East Asia Summit (EAS) free
trade agreement (FTA) and regional post-GFC cooperation are also
discussed.
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Trends and Major Features of India’s Trade

Relations with Asia and its Major Partners
Since its independence in 1947, India has regarded itself as a major
international player. It has been at the forefront of developing
country activism, a member of the Non-Aligned Movement (NAM),
the United Nations and the Commonwealth. Recently, the country
has sought to expand its cooperation with East Asia and ASEAN
(DFAT, 2011). For nearly four decades after independence, however,
India’s economic development through a number of expansive
five-year plans was relatively sluggish and apparently failed to
some extent to realise the country’s full economic potential. As a
result of the balance-of-payments and investment crises in 1991
and the subsequent introduction of the reform process, ‘economic
diplomacy’, and the ‘Look East’ policy with Asia, India is showing
clear signs of realising what the country can and wants to achieve
as an international player. We note that while India is the major
power in South Asia and its relations with its neighbours had
traditionally governed the tenor of foreign relations in the region,
its major strategic focus has more recently broadened, notably
towards East Asia in general and ASEAN in particular (ibid.).
Like Australia, India has been pursuing a combined mul-
tilateral, regional and bilateral approach to trade policy with its
major trade partners. For example, while the country is a WTO
member, it also has an India–Sri Lanka FTA in operation since
2002; it signed a Comprehensive Economic Cooperation Agree-
ment with Singapore in June 2005, and entered the first stage of
an India–Thailand FTA in September 2004, although there has
been no further implementation of this FTA. In late 1995, India
was granted full dialogue partner status with ASEAN and was
admitted as a member of the ASEAN Regional Forum in July 1996.
An ASEAN–India FTA was signed in 2009. India, together with
Australia and New Zealand, is also an EAS member.
 India–ASEAN Trade, FDI and Growth •2 7

In 2002, India participated in its first summit meeting

with ASEAN. In 2003, it signed three significant agreements with
ASEAN including the important ASEAN-friendly Treaty of Amity
and Cooperation. On 14 December 2005, India attended the first
East Asia Summit meeting where, with the world’s major trading
bloc leaders, it endorsed an enlarged ASEAN and subsequently an
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EAS FTA. As it stands now, however, India is not an Asia-Pacific

Economic Co-operation (APEC, a group spearheaded by Australia)
member.
As a result of this national eco-political approach with
apparently clear leadership foresight, the world’s trading blocs
have seen rapid growth and strong dynamics in their trade with
India. India’s recent growth and the trends and patterns of trade
with its top-10s trading blocs during 1990 and 2008 are shown in
Figures 1.1 (exports) and 1.2 (imports). During the period 1990–
2008, the average share of the top-10 trade to India’s total trade is
55.74 per cent for exports and 42.75 per cent for imports. In terms
of total trade, the data shows that, with a modest pre-reform start
of US$ 17.81 billion in 1990, India’s total exports reached US$
187.35 billion in 2008 (or a rise of 52.9 per cent annual average).
The country’s imports also show a faster rising trend with US$
23.99 billion in 1990 and a peak of US$ 299.49 billion in 2008 (or
an increase of 63.8 per cent annual average). The largest increases

Figure 1.1: India’s Top 10 Export Destination Trend, in US$ Millions

30000
US
25000 UAE
20000 China
UK
15000
SG
10000 HK
Germany
5000
Belgium
0 Italy
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008

Japan

Source: ADB (Asian Development Bank). 2011. Available at [Link]

Books/Key_Indicators/2010/[Link] (accessed 15 January 2011); and author’s
calculations.
 28•Tran Van Hoa

Figure 1.2: India’s Top 10 Import Source Trend, in US$ Millions

40000
China
35000
US
30000 Germany
25000 SG
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20000 Australia
15000 Belgium
10000 UAE
5000 Korea
0 UK
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
Japan

Source: ADB (Asian Development Bank). 2011. Available at [Link]

Books/Key_Indicators/2010/[Link] (accessed 15 January 2011); and author’s calculations.

in India’s exports and imports, however, seem to coincide with the

country’s World Trade Organisation (WTO) membership in 1995
and especially the reforms in the early 2000s.
In terms of market shares, the data in Figure 1.3 show
that, in 2008, the US was still India’s largest export market
(13.07 per cent), followed by China (11.09 per cent) and the
UAE (8.93 per cent). However, also in 2008, India’s largest import
source (Figure 1.4) was China (11.89 per cent), followed by the

Figure 1.3: India’s Top 10 Export Destination Shares, 2008

13.07
14.00
11.09
12.00
10.00 8.93
8.00
6.00 3.74 4.33 3.75 3.43
4.00 2.68 2.46 2.54
2.00
0.00
n
na

m
SG

ly
S

AE

pa
an
U

iu

Ita
U

H
hi
U

lg

Ja
m
C

Be
er
G

Source: ADB (Asian Development Bank). 2011. Available at [Link]

Books/Key_Indicators/2010/[Link] (accessed 15 January 2011); and author’s calculations.
 India–ASEAN Trade, FDI and Growth •2 9

Figure 1.4: India’s Top 10 Import Source Shares, 2008

15.00 11.89
10.00 6.86 4.38 4.55
4.04 SVP
2.72 2.93 2.77 2.74 2.90
5.00
0.00
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na

n
m
Be ia

a
y

Au SG
er S

AE

K
pa
re
an

l
U

iu

U
ra
hi

Ko
U
lg

Ja
m
C

st
G

Source: ADB (Asian Development Bank). 2011. Available at [Link]

Books/Key_Indicators/2010/[Link] (accessed 15 January 2011); and author’s calculations.

US (6.86 per cent) and Singapore (4.55 per cent). Japan, a major
trading country in Asia, had, however, been playing a small role in
trade with India with 2.54 per cent and 2.90 per cent of export and
import shares respectively.
The shares of India’s total trade with its world trade
partners (12 countries or blocs) in 2008 are given in Figure 1.5.
The data here indicate that while all developing countries’ trade
with India accounted for 42.6 per cent and 32.0 per cent of its
exports and imports respectively, ASEAN (denoted by SEA) trade
with India played only a small part in India’s global markets
(8.6 per cent for exports and 8.4 per cent of imports). ASEAN–

Figure 1.5: India’s World Trade Partner Shares, 2008

50.0 38.4 42.6

40.0 14.7 30.2 32.031.6
25.7
30.0 20.1 25.5 24.6
18.5 16.
20.0 14.6 9.1 5.8 8.5 8.4 7.7
3.2 2.1 2.1 4.1 3.4 2.4
10.0 0.5 0.9
0.0
-O FTA

AF A

LA
IA

A
D

EA EC

AL C

EC
ER
EU
EU

SE

IC
SI
EC

S
N

ID

SP
TH
ST

LA

R
EA
A

O
O

N
O
C
IA

Export %
AS

Import s

Source: Reserve Bank of India. 2011. Available at [Link]

(accessed 11 January 2011); and author’s calculations.
 30•Tran Van Hoa

Figure 1.6: ASEAN–India Trade Growth and Share

50 10
44.7
41.8 41.5 8.8 8.5
40 39.5
37.0 8.3 8.1
7.8 8
7.4 7.6 7.1 7.2 7.3 33.0 7.5
30 7.2
6.6 6.6
23.9 22.9
20 5.8 20.8 6
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18.0 5.65.7 5.8 SEATC

4.9 5.1 13.7
10 4.4 9.1 SEATS
8.7 8.0 4
0 0.0 -1.1 0.9
-2.2 -6.5
-0.2 2
88

Ja 0
92

Ja 6
98

00

Ja 2

Ja 6
08
94

04
-10
9

0
n/

n/

n/

n/

n/

n/

n/

n/

n/
n/

n/
Ja

Ja

Ja

Ja

Ja

Ja
Ja

-20 0

Source: Reserve Bank of India. 2011. Available at [Link]

(accessed 11 January 2011); and author’s calculations.
Note: SEATS and SEATC ⫽ ASEAN–India trade share and growth respectively.

India historical total trade (exports and imports) share and the
growth of this trade over the period 1988 to 2008 are shown in
Figure 1.6. The figure also shows the fast growing but volatile
trend of ASEAN–India trade (SEATC), especially during the pre-
reform early 1990s period and the 1997 Asia economic crisis,
and less so after its early 2000s reform. The impact of regional
and global crises and domestic reforms on ASEAN–India trade
seems to be an important causal factor. The figure, however,
indicates only a slowly and steadily rising trend of its share in
India’s total global trade (SEATS).
The relatively minor role played by the ASEAN in India’s
global trade activities and economic performance and the volatile
nature of ASEAN–India trade in recent years, as depicted by the
information given in these figures, indicates both the challenges
and opportunities in future ASEAN–India economic and trade
relations, and their strategic study is highly desirable from both
basic and practical perspectives. A number of approaches (theo-
retical, scenario or computable general-equilibrium, and politi-
cal economy) have been taken to deal with these challenges and
opportunities but with limited success. A new improved modelling
approach with credible outcomes and policy recommendations will
be proposed in the following sections.
 India–ASEAN Trade, FDI and Growth •3 1

The WTO, Enlarged ASEAN, India’s ‘Look East’

Policy and Economic Diplomacy
As already discussed, India, like Australia and many other
countries in the world, has sought multilateral, plurilateral and
bilateral trade agreements with its major trading partners for
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essentially its own economic benefits. Conceptually, a number of

different opinions and interpretations have emerged as a result of
growing FTAs and regional trade agreements (RTAs) worldwide
and especially in the Asian region. On the one hand, it is claimed,
mainly by multilateral trade advocates, commissioned consultants
and government trade officials, that a bilateral and multilateral
trade system can be mutually reinforcing. For example, FTAs can
accelerate trade liberalisation and somehow set a high standard
for the multilateral system. In addition, the experience and skills
gained through FTA negotiations can be of use to multilateral trade
negotiations within the WTO (DFAT, 2011).
On the other hand, it is claimed, chiefly by independent
academics (whose findings are known to be less subjective or
less self-serving), that the WTO is not a multilateral FTA but a
negotiated trade agreement, the objectives of which are far less
comprehensive or encompassing than those of an FTA (see also
DFAT [2011] for the Australian government’s view on this). More
specifically, while the initial rules of the WTO have been slowly
relaxed to more appropriately encompass not only trade in goods
and trade-related services and trade-related investment (through
Trade Related Investment Measures [TRIMS], Trade Related
Aspects of Intellectual Property Rights [TRIPS], and TRIPS Plus),
they are still inadequate in a modern global economy where
different countries or different regions are still governed by their
different development stages, different sets of ‘national treatment
or benefits’, different human and physical endowments, and
subsequently vastly different growth paths. In the ‘hurried’
development of the WTO rules to govern FTAs (or even RTAs),
some key WTO members (such as Australia) regard these rules to
be in need of clarification (DFAT, 2011). The 2001 Doha Meeting
of the WTO and the Sutherland report prepared for the WTO in
2004 clearly indicate these concerns and recommend clarifying
and improving effective disciplines and meaningful procedures to
deal more appropriately with FTAs and their relationship with the
 32•Tran Van Hoa

WTO. The adoption of a new transparency mechanism by WTO

members on 14 December 2006 also reflects some improvement
in this respect. However, the current debacles of the Doha Round
between the US, the EU (developed countries) on the one hand
and Brazil and India (developing countries) on the other hand
which led to the suspension of WTO negotiations in 2006 clearly
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show the preference of FTAs over the multilateral trading system

as it stands or is projected (see also other criticisms of the WTO
in Lloyd, [2010]). Studies on an APEC FTA were considered by
the APEC leaders at their annual meeting in Sydney early in
September 2007. An APEC FTA has been regarded as a middle
system between the WTO and the EAS FTA framework. At this
stage, however, while scenario or confirmatory studies of those
RTA and FTA proposals is extensive (ASEAN, 2011), rigorous and
substantive studies incorporating RTA developments and India’s
reform, ‘Look East’ policy, and ‘economic diplomacy’ amidst
the GFC with credible or reliable policy recommendations for
improved informed debates and policy discussions are still very
limited.
As a response to this challenge and to provide credible
policy outcomes for ASEAN–India relations, a causal econometric
model of ASEAN–India incorporating endogenous growth and
trade theories, the possible effects of the WTO, RTAs, economic
reforms and regional and global economic and financial crises has
been developed in the following sections to provide significant
and reliable inputs for use by academics and other researchers,
RTA negotiators, and policy makers for a more credible economic,
trade and external relations policy analysis. The model can also be
used to provide empirical support (or a lack of it) to India’s recent
reforms, ‘Look East’ policy, ‘economic diplomacy’, and credible
scenarios for FTA, RTA and other plurilateral and multilateral
cooperation frameworks.

A Model of ASEAN–India Trade and Economic

Growth for Economic Integration Policy Analysis
In a number of recent papers, Tran Van Hoa (2002a, 2004, 2005,
2007c, 2008, 2010) introduces a simple, new, effective, general
and flexible modelling approach (the endogenous growth-trade
 India–ASEAN Trade, FDI and Growth •3 3

theory or EGT for short) to empirically study trade and its causal
link to growth in major developing countries in Asia. The major
and novel features of an EGT model are that unlike other popular
modelling studies in this genre (e.g., computable general equi-
librium [CGE]/global trade analysis project [GTAP] and growth
regression), (i) it explicitly incorporates the interdependence
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(reverse causality or feedback) between trade, growth and, signifi-

cantly, major macroeconomic conditionality or activities affecting
both trade and growth in the trading economies (Krueger, 2007);
(ii) it assumes complex non-linearity in the functional form;
(iii) it incorporates merchandise trade, FDI, services, and other
reform and non-economic events that have affected ASEAN–India
trade and growth in recent years (Johansen, 1982; Tran, 2001,
2002b).
Other existing modelling approaches which have been
used for this kind of study are inappropriate or not credible
for policy uses because of their structural and econometric
limitations. For example, the CGE/GTAP is essentially scenario-
based or confirmatory with its assumed causal relationships and
given impact parameters. The gravity theory (Frankel and Romer,
1999) is beset with serious cross-country heterogeneity and no
endogeneity. The growth regression is econometrically fragile
(Levine and Renelt, 1992) and lacks the well-known circular
causality in the sense of Marshall or Haavelmo among economic
(e.g., trade, growth, monetary, fiscal, and industry policies)
activities (see also Krueger, 2007). The specification of a linear
function for empirical trade-growth studies has been increasingly
regarded as unsuitable (Minier, 2007). Previous studies have also
demonstrated the excellent modelling performance of the EGT
model when this performance is assessed by the Friedman (1953)
or Kydland (2006) data-model consistency criterion. In addition,
as the economic variables in the EGT model (being planar
approximations to any functional form) are expressed as their rates
of change, all parameters are simply the elasticities, the central
concept in economic theory. Finally, the model has full dynamics in
this specification: the model’s findings can be regarded as short-run
or Granger causality outcomes if all these variables are integrated
at degree zero, or they can be interpreted as long-run outcomes
in the sense of Engle and Granger cointegration causality if all of
these variables are I(1).
 34•Tran Van Hoa

The Model
The flexible EGT growth-trade causality model is built on the work
of Frankel and Romer (1999), Tran (2002a, 2004, 2005, 2007c,
2008, 2010), and emerging thinking on contemporary economy-
wide policy modelling for developing economies (Krueger, 2007)
and appropriate inferential analysis (Kilian, 2009). It contains
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testable determinant hypotheses for ASEAN–India relations to

study the causal aspects of trade and growth and has features
relevant to ASEAN’s and India’s development in the past 20 years
or so (where data are available). The model can be written for
illustration, say for GDP and trade in goods (T), in implicit form as
(GDP, GDPP, T, FDI, F, S, XR, TT) ⫽ 0, or as two normalised implicit
structural functions GDP(.) and T(.)
GDP ⫽ GDP(T, FDI, F, S) (1)
T ⫽ T(GDP, GDPP, XR, TT, S) (2)
where FDI ⫽ foreign direct investment, F ⫽ financial services, S ⫽
crises, reform or RTA events, GDPP ⫽ trade partner GDP, XR ⫽ real
exchange rates, and TT ⫽ terms of trade. As the model is implicit
and can be highly non-linear, it is not statistically estimable. For
empirical implementation, Tran Van Hoa (1992) has demonstrated
that the model can be written mathematically equivalently, using
Taylor’s series planar approximations (see Baier and Bergstrand,
2008, for a more recent use), as two linear stochastic equations
Y% ⫽ a1 ⫹ a2T% ⫹ a3FDI% ⫹ a4F% ⫹ a5S ⫹ u1 (3)
T% ⫽ b1 ⫹ b2Y% ⫹ b3YT% ⫹ b4XR% ⫹ b5TT% ⫹ b6S ⫹ u2 (4)
where % indicates the rate of change, the ‘u’s denote error terms,
and the ‘a’s and ‘b’s are the elasticities (a2–a4, b2–b5) or simply
impact parameters (a5, b6). The model’s theoretical rationale can
be described as follows: In (1) and (3), India’s GDP growth (Y%),
in consistence with the expenditure framework of the SNA93 or
SNA08, the FTA-RTA scope (ASEAN, 2011), and non-steady state
political economy (McMahon et al., 2009), is assumed to be (or to
be tested) as being dependent on its trade in goods with the ASEAN
(T), other factors of production (such as FDI [capital] and financial
services [F] or labour), crises, shocks, policy reforms or RTA events
(S). But this India–ASEAN trade (T) is also causally affected by
India’s and ASEAN’s GDP (and FDI and F) as expressed in (2) and
 India–ASEAN Trade, FDI and Growth •3 5

(4). In (2) and (4), ASEAN–India trade is simply a derived demand

equation for tradable goods as stipulated in standard microeco-
nomic and international trade theory. The equations for endog-
enous FDI and services or other suitably endogenised variables in
the more complete model can be similarly structurally specified.
As a simultaneous-equation model, the use of regression
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or maximum likelihood estimation methods will have to assume

exogeneity in the RHS variables and, as a result, produce biased,
inconsistent or unreliable findings, and a fortiori not credible policy
outcomes. When all parameters in (3) and (4) are a priori assumed
or given and the equations are made non-stochastic (i.e., u1 ⫽
u2 ⫽ 0), the model can be interpreted as a simplified time-varying
version of the CGE/GTAP analysis and its uses and policy recom-
mendations are simply scenario setting or confirmatory in nature.
As the multi-equation model (3)–(4) has jointly depend-
ent variables and equations, an instrumental-variables (IV) system
method such as the 3SLS or the generalised method of moments
(GMM) is more appropriate statistically (in terms of paramet-
ric consistency criteria) and economic-theoretically (in terms of
Marshall and Haavelmo’s economy-wide transmission mecha-
nism reality and the increasingly recognised influence of a coun-
try’s economic ‘conditionality’ on its domestic and international
activities) (Krueger, 2007; Kilian, 2009). Appropriate IVs for the
model include exogenously determined variables affecting growth
and trade in the ASEAN and India and satisfying their statistical
orthogonality or over-identifying restriction requirements. Assum-
ing, for convenience and for lack of sufficient sampling sizes for
the data, that GDP of India’s trade partner in focus (i.e., ASEAN)
is a proxy for all variables reflecting their own economic activities
in addition to policies and shocks in the ASEAN, the IVs for our
EGT model for ASEAN–India include the exogenous factors such
as ASEAN’s GDP (named YT), fiscal policy (FP), monetary policy
(MP), inflation pressure (INF) (see Romer, 1993), real exchange
rates (XR) (see Rose, 2000), industry policy (IP) (see Otto et al.,
2002), population (POP)/a gravity factor (see Frankel and Romer,
1999), and structural change (S) (see Johansen, 1982 and Tran,
2004) in India. The tests for significant causality between India’s
trade with the ASEAN and its impact on the country’s growth are
then based on the estimation and testing of (3) by the GMM, con-
ventional diagnostics testing procedures, and, more importantly,
 36•Tran Van Hoa

the Friedman (1953)–Kydland (2006) model-data consistency or

realism criterion.

The Data
Trade, economic and ‘conditionality’ or IV data for the estimation
were obtained from the databases of the United Nations, the
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Asian Development Bank and the Reserve Bank of India/India’s

Department of Commerce. For consistency with previous studies,
all economic data (except GDP growth) are in current value.
In our study, all original data are obtained as annual and then
transformed to their ratios (when appropriate). The ratio variables
include ASEAN–India trade (T) in goods (exports and imports),
FDI, financial services (F), money supply (M3), government
budget (G), and debt (D), all divided by India’s GDP. Other non-
ratio variables include population (a gravity theory factor proxy)
and binary variables representing the occurrence of the economic,
financial and other major crises, policy shift or reforms over the
period 1990–2008. All non-binary variables are then converted
to their percentage rates of change. The use of this percentage
measurement is a main feature of our EGT approach and avoids the
problem of a priori known functional forms (see earlier) and also
of logarithmic transformations for negative data (such as budget
[fiscal] or current account deficits). In this chapter, we have
focussed on a unidirectional direction of trade and growth in a
‘dual’ context, that is, India’s trade with the ASEAN and its possible
causal impact on India’s growth (the so-called India perspective).
The existence of this causality is the foundation of ASEAN–India
trade agreements or relations as discussed.

Substantive Findings and Their Policy Modelling

Realism Properties
The empirical findings for the structural growth (3) and trade
(4) equations in our EGT model of India’s growth as a result of
trade with the ASEAN are given in Table 1.1 together with their
conventional (R, F, DW) and advanced diagnostic (time-varying
parameters and GMM over-identifying restrictions) tests.
 India–ASEAN Trade, FDI and Growth •3 7

Table 1.1: ASEAN–India Trade and Its Impact on India’s Growth:

EGT Modelling in Flexible Structural Form, 1990–2008

India Growth ASEAN–India Trade

OLS GMM OLS GMM
Growth EGT Growth EGT
Regression Structural Regression Structural
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Const 8.068** 7.673** 8.833 ⫺2.546

(0.991) (0.675) (14.371) (10.197)
ASEAN–India- ⫺0.029 ⫺0.014
Trade/GDP (0.027)) (0.019)
FDI/GDP ⫺0.006 ⫺0.002
(0.009) (0.006)
Services/GDP 0.002** 0.002**
(0.001) (0.001)
India’s Growth ⫺2.350 ⫺0.663
(2.076) (1.621)
ASEAN Growth 4.951* 5.222**
(2.533) (1.761)
REER ⫺2.390** ⫺2.481**
(0.873) (0.614)
Terms of Trade ⫺0.720* ⫺0.835**
(0.345) (0.257)
Asia Crisis 1997 ⫺2.092* ⫺1.690**
(1.074) (0.703)
Terrorist ⫺1.919 ⫺2.458** ⫺16.466* ⫺16.514**
Attacks 2001 (1.304) (0.980) (7.649) (4.723)
India 5.420** 5.491** 21.974 16.719**
Reforms 2004 (1.427) (1.073) (12.274) (8.345)
Pre-GFC 2007 ⫺0.702 ⫺0.687 16.184 20.993**
(1.099) (0.773) (9.975) (6.612)
R-Squared 0.806 0.777 0.763 0.735
F 4.131** 3.222*
DW 2.156 2.015 2.267 2.393
CuSumSq Test p 0.250 0.133
Hansen Test p 0.089 0.089
Source: Author’s estimates by OLS and GMM of the EGT model by TSP software.
Note: **=Significant at 5%, *=Significant at 10%, estimated standard error in braces,
CuSumSq Test p=Brown-Durbin-Evans test for significant time-varying regression coefficients,
Hansen test p=test of over-identifying restrictions in GMM estimation.
 38•Tran Van Hoa

Judged from the table, the standard statistical perform-

ance of the estimated EGT models for ASEAN–India growth and
trade appears good in terms of the R2, F, DW, and CuSumSq
values. The performance of the models can also be more accu-
rately evaluated by the Kydland (2006) data-model consistency
criterion where the trend gap and discrepancy between historical
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data and predictions have to be tight and small. The criterion

was advocated earlier by Milton Friedman (1953) in the sense of
model (theory) and reality consistency and it seems to be over-
looked by serious modellers and policy makers alike in recent
years. This observation-by-observation modelling performance is
given in Figure 1.7 for India’s growth and in Figure 1.8 for its
total trade with the ASEAN.
A visual indicates that the models emulate the troughs,
peaks and turning points of India’s growth and its trade with the
ASEAN (as well as endogenous FDI and services — not reported here)
very well. While the modelling performance of India’s growth is
interesting as the two major troughs attributable to the 1997 Asia
crisis and the 2001 World Trade Centre terrorist attacks were accu-
rately emulated, the ASEAN–India trade is particularly interesting
as this trade experienced a highly volatile period in the early 1990s
(reform), mid-1990s (Asia crisis), mid-2000s (reform) and late
2000s (pre-GFC) in the Indian economy.

Figure 1.7: EGT Modelling Performance of India’s Growth:

Friedman–Kydland Criterion

12.00
10.00
8.00
6.00
4.00
2.00
0.00
1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

YC YCGF

Source: Estimates and forecasts by GMM of the EGT model by TSP software.
Note: YC and YCGF⫽India’s growth and its prediction by EGT-GMM modelling.
 India–ASEAN Trade, FDI and Growth •3 9

Figure 1.8: EGT Modelling Performance of ASEAN–

India Trade: Friedman–Kydland Criterion

50.00
40.00
30.00
20.00
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10.00
0.00
⫺10.00
⫺20.00
1994

1995
1996
1997
1998
1999
2000

2001
2002

2003
2004
2005
2006

2007
2008
TY TYGF

Source: Estimates and forecasts by GMM of the EGT model by TSP software.
Note: TY and TYGF⫽ASEAN-India trade/GDP and its prediction by EGT-GMM modelling.

Implications for ASEAN–India Trade, India’s

Regional Economic Integration Policy and
External Relations
What then are the implications of our substantive empirical
findings for informed discussions or even for use in negotiations
or trade policy formulation relevant to economic and trade
relations between India and the ASEAN within the framework
of globalisation, India’s bilateral and plurilateral (ASEAN–India)
trade agreements or ASEAN Plus and EAS FTA?

Does ASEAN–India Trade Significantly

Contribute to India’s Growth?
The major claim of supporters and exponents of India’s ‘Look East’
policy and ‘economic diplomacy’ is that this engagement with Asia
will enhance India’s economic performance and export growth
(in addition to regional political stability and cooperation). Our
empirical findings by two different kinds of model specification
and estimation (i.e., growth regression-OLS and EGT-GMM)
reported here appear to not support this assertion. The findings
are robust with respect to several modelling specifications (or
 40•Tran Van Hoa

‘computational experiments’ as advocated by Kydland [2006]

recently) of a bilateral kind between India and the ASEAN. There
are three important policy implications here. First, the findings
would also not be surprising due to the relatively small share the
ASEAN–India trade had played in India’s global trade explosion
since its important reform in the early 1990s (Figures 1.5–1.6).
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This is a major challenge for India’s trade policy with the ASEAN
in the near future. Second, appropriate policy should be designed
to maintain stability in this trade which might have affected the
benefits to India’s economic growth. Third, the findings also
indicate that ample opportunities exist for India to expand its trade
with the ASEAN via trade promotion, RTAs and economic and
trade cooperation. Recent increase in ASEAN–India trade indicates
favourable progress in this direction.

What Determines ASEAN–India Trade?

One interesting finding from our model is that India’s real exchange
rate fluctuations significantly reduce ASEAN–India trade, and
changes in its terms of trade also statistically dampen it. Equally
interesting is the unexpected evidence that India’s growth (or a
source of demand) has no impact on ASEAN–India trade. What
then are the real drivers of ASEAN–India trade? Our findings show
that while the real and highly significant drivers of ASEAN–India
trade are ASEAN’s economic development and, more importantly,
India’s economic and trade reform policy, this trade can, however,
be seriously and adversely affected by major regional crises such
as the 1997 Asia economic meltdown and global terrorist attacks.
Some implications for India’s policy makers for improved ASEAN–
India trade may be clear: enhancement of India’s reforms and
regional cooperation through FTAs and partnerships to promote
regional economic growth, development and political stability.

Growth Regression versus Flexible

EGT Simultaneous-Equation Modelling
Most contemporary trade-growth studies are based on either a
descriptive correlational or non-causal approach, CGE/GTAP or
growth regression analysis, all favoured by commissioned consult-
ants, neoclassical economists and institutional economics and trade
 India–ASEAN Trade, FDI and Growth •4 1

experts. The problems of reliability, fragility and policy credibility

with these approaches are well-known. The EGT findings reported in
Table 1.1 show the large difference in responses and impact param-
eter estimates not only in magnitude but also in significance level
between growth regression and EGT approaches being applied to
equations (3) and (4). An important methodological implication is
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that, when a model ignores reverse causality or feedback in eco-

nomic and trade activities and the deep influence of a country’s
economic ‘conditionality’ on these activities, its policy recommenda-
tions should be interpreted and used only with great reservation.
From another perspective, various researchers on high-growth econ-
omies such as Korea (e.g., Harvie and Lee, 2002) have claimed that
Korea’s growth was supported by the so-called East Asia Economic
Model. This model is not a big-bang framework where all economic,
trade, industry, and administration reforms emerge and have impact
in a very short time span (e.g., in one government election term),
but it consists in fact of a sequence of policy reforms (for example,
of the monetary, fiscal and industry kind), that were gradually intro-
duced over a number of years and deeply imprinted in the activi-
ties or infrastructure of the economy. This aspect of policy model-
ling cannot be captured by a growth regression approach where it
is usually overlooked. In this context, the GMM-based findings from
our EGT models are more appropriate for econometric study and
efficient policy analysis as they have taken into account this aspect
in the form of an auxiliary structural equation or a series of auxil-
iary structural equations and the IVs representing India’s economic
‘conditionality’.

Are FDI and Services Important Engines of

India’s Growth?
The findings reported show that FDI, at least at its aggregate level
and despite its fairly recent strong trend, does not make a positive
and significant contribution to India’s economic performance. The
volume and effective utilisation of FDI may be two reasons for
this empirical non-significance. An expected finding is, however,
that India’s net services are found to be a beneficial and highly
significant factor in India’s economic performance. This can be
explained in a number of ways. First, India’s services have been
widely regarded as a key sector for its export income, and our
 42•Tran Van Hoa

findings simply lend strong statistical support to this perception.

Second, there may be complementarity or substitutability between
India’s FDI and net services. This aspect of international trade
would need further research.

The Role of Domestic Reforms and Regional Shocks in

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India’s Trade and Economic Performance

While sudden crises, shocks and major gradual policy reforms
have been acknowledged (even by CGE pioneers) as important
sources of fluctuations in economic performance worldwide (see
Johansen, 1982; Tran, 2001, 2002b), they have rarely been incor-
porated in such well-known economic policy modelling studies as
descriptive or graphical analysis, the CGE/GTAP, gravity theory,
growth regression, or in a more realistic (e.g., with multiple struc-
tural breaks and with temporary or non-decaying effects) manner
in the often-used long-term causality cointegration analysis. A
novel modelling feature of the EGT approach is in its flexibility in
accommodating these events. The findings from Table 1.1 indicate
that all three major events focussed on in our study (i.e., the Asia
crisis of 1997, terrorist attacks on the World Trade Centre in New
York and on the Pentagon in Washington D.C. in 2001, and India’s
further reforms [‘Look East’ and ‘economic diplomacy’ in the early
2000s]) do have a strong impact on India’s economic growth and
especially ASEAN–India trade. The findings that a severe adverse
and strongly significant impact of the 2 July 1997 Asia crisis
and 11 September 2001 attacks occurred on India’s growth only
confirm the well-supported views and facts on these regional and
global crises’ serious contagion (Tran, 2001, 2002b). However,
the beneficial effects of good economic governance or construc-
tive and ‘correct’ policy reforms such as India’s ‘Look East’ policy
and ‘economic diplomacy’ of the early 2000s seem to have been
substantiated empirically from our models. These lend credibility
to our modelling study and its policy recommendations. Another
implication of the findings for similar impact studies is that, due
to the far-reaching effects of crises, shocks and policy change on a
large number of sectors in an economy (the present GFC is a good
example), the need to specify these aspects of structural change in
a multi-equation or even single-equation policy model for credible
predictive policy analysis is clearly desirable and appropriate.
 India–ASEAN Trade, FDI and Growth •4 3

Implications for India’s ‘Look East’ Policy, Economic

Diplomacy, Globalisation and Regional Geopolitical
Competition and Trade Agreements
This chapter has focussed chiefly on ASEAN–India trade and its
effect on India’s growth, in the context of increasing globalisation
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and RTAs, major national policy reforms, and the emergence of

severe crises and shocks. The findings show the negligible impact of
this trade on India’s economic growth in the past, but, significantly,
this trade is profoundly affected by economic development in the
ASEAN. ASEAN–India trade is closely tied to ASEAN growth. The
findings also show the important effects of policy reform and crises
on India’s growth and ASEAN–India trade. These findings on this
trade’s impact and the difficulties encountered in FTA negotiations
and implementation of a number of ASEAN–India bilateral FTAs
(e.g., India–Singapore and India–Thailand) pose great challenges
to ASEAN–India negotiators and policy makers. Opportunities
are, however, plentiful to promote closer economic relations or
geopolitical cooperation and to enhance trade between India and
the ASEAN in particular and between India and Asia (especially
China which is currently the regional focus) in general, for regional
mutual benefits. An EAS FTA in operation would be a central trade
policy for India to pursue in the near future in this context. It is
also consistent with India’s sound and beneficial ‘Look East’ policy
and ‘economic diplomacy’.

Conclusion
In the preceding sections, we have described a new endogenous
growth-trade model and, using historical data, attempted to
understand better India–ASEAN economic and trade relations,
and to provide credible evidence-based policy options for
improved India–ASEAN economic, trade and external relations
in the context of India’s ‘Look East’ policy, ‘economic diplomacy’,
regional integration and its post-global financial crisis policies. The
findings, which are credible as measured by the Friedman–Kydland
realism test, lend statistical support to the general ‘perceptions’
that the impact of India–ASEAN trade and FDI on India’s growth
is not significant, and that the service sector has been the biggest
 44•Tran Van Hoa

contribution to the country’s growth. Interestingly, both India’s real

exchange rates and terms of trade have had a dampening effect on
India–ASEAN trade. The findings also show the severely damaging
effects of crises on India’s growth and trade, and at the same
time, the highly beneficial impact of ‘good’ reform policy. Strong
cooperation between India and its regional and global partners is
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recommended to avoid or better manage future crises.

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 2
FDI in Sensitive Sectors:
The Case of the Retail Sector in India

Tanu M. Goyal and Arpita Mukherjee

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T
he Indian economy is on a high growth trajectory. The gross
domestic product (GDP) has grown at an average annual
rate of 7 per cent over the past decade and in 2010 India was
ranked as the fourth-largest economy in terms of its purchasing
power parity (PPP).1 With economic growth, the retail sector has
modernised. Traditionally, the Indian retail sector was characterised
by a large number of small mom-and-pop outlets (known as
unorganised retailers), run on family labour. The economic reforms
of the 1990s propelled the entry of Indian corporates and foreign
retailers into this segment and since 1995 the sector has witnessed
a consistent double-digit growth. In fact, with the growing GDP,
higher purchasing power and rising consumerism, the sector is
expected to grow further. The growing market has made India an
attractive destination for foreign investment. In 2010, India was
ranked the third most attractive destination among 30 emerging
markets for foreign retailers (A. T. Kearney, 2010).
A number of foreign retailers have shown interest in
investing in India. Indian corporates, too, are keen to enter into
partnership with foreign players. However, retail is one of the few
sectors in which foreign direct investment (FDI) is restricted. In
1997, when the rest of the economy was being liberalised, a ban
on FDI was imposed in this sector due to the fear of job losses in
the traditional sector and threat of FDI outflows. India is one of the
few countries to have imposed FDI restrictions on retail. Retail is a
politically sensitive sector in India. The country is under constant
pressure from its trading partners in the World Trade Organisation
(WTO) and in its Free Trade Agreements (FTAs) to liberalise retail.
The first major step towards liberalisation was in 2006 when up
to 51 per cent FDI was allowed in single-brand retail subject to
certain conditions. The next major step was in November 2011
when the Indian Cabinet approved 100 per cent FDI in single-
brand retail and 51 per cent FDI in multi-brand retail subject to
 48•Tanu M. Goyal and Arpita Mukherjee

certain conditions. Based on the proposal, the government allowed

100 per cent FDI in single-brand retail subject to the proposed
conditions while the proposed multi-brand policy has not been
enacted. India is probably the only country which has a brand-
linked FDI policy.2
The proposed policy changes need to be examined in the
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context of the effort made by the government to liberalise retail.

It is worth mentioning that in 2010, the Department of Industrial
Policy and Promotion (DIPP) released a discussion paper on
‘Foreign Direct Investment (FDI) in Multi-Brand Retail Trading’ to
facilitate discussion and debate on whether FDI should be allowed
in multi-brand retail and if so, what the conditions should be. While
the debate on the benefits and concerns of allowing FDI in retail in
India continues, this chapter tries to make policy recommendations
based on a pan-India survey of 1,000 stakeholders. The first section
gives an overview of the retail sector in India. The second section
critically examines the retail policy. As the retail sector is regulated
across the world, the third section provides an overview of retail
regulations in different countries. The fourth section presents a
review of the literature and existing views of FDI in retail. The fifth
section lays down the survey design and research methodology.
The sixth section summarises the survey findings and the last
section provides policy recommendations.

Overview of the Retail Sector in India

Retail is the largest private sector in India. However, there is
no official source of data for the sector. The National Sample
Survey Organisation (NSSO) has clubbed retail under ‘trade,
hotels, transport and communication’. In 2009–10, the share of
this segment in the GDP was around 24.5 per cent.3 The share
of trade to GDP was around 15 per cent and the share of retail
trade was estimated to be 8.1 per cent (DIPP, 2010). In 2010,
the size of organised retail was $20.5 billion which accounted for
approximately 5 per cent of the total retail market. Organised retail
has been growing at the rate of 30 per cent over the past decade
and its share is expected to increase to $53.5 billion in 2013 with a
share of 10 per cent of the retail market. The Indian retail market
is expected to grow up to $535 billion by 2013 from $410 billion
in 2010.4
 FDI in Sensitive Sectors •4 9

Retail is the second largest employer after agriculture. As

per the latest NSSO’s 64th Round, in 2007–8 retail trade employed
7.2 per cent of the total workforce and provided job opportunities
to 33.1 million persons (DIPP, 2010).
In terms of the different retail segments, food and grocery
is the largest segment of retail with a share of around 50 per cent in
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2010. However, the share of food and grocery is likely to reduce over
time and that of discretionary items like personal transportation,
travel and leisure is likely to increase (see Figure 2.1).

Figure 2.1: Share of Different Segments in the Indian Retail Market,

2009 and 2014

45.9
Food and Grocery 52.4

7.9
Healthcare 6.7

Apparel and home 6.1

textiles 6.3

Housing 6.4
6.2

6.4
Education 5.6

5.7
Telecom 4.9

Jewellery and 4.9

watches 4.9

Personal transport 5.3

4.7

2.8
Travel and leisure 2.4

Consumer durables 2.4

2.2

2
Home furnishing 2.1

2
Personal care 1.9

1.1
Eating out 0.9

0.8
Footwear 0.7

Health and beauty 0.3

services 0.2

0 10 20 30 40 50 60
2014 2009

Source: Technopak. 2010. ‘Overview of India’s Consumer and Retail Sector’, presented at 2nd
Leadership Forum, Thursday, 18 February 2010, Gurgaon (NCR), p. 12.
 50•Tanu M. Goyal and Arpita Mukherjee

The share of organised retail varies across different product

segments. Figure 2.2 shows that there are more organised players
in segments like watches and footwear, while around 99 per cent
of the food and grocery retailers are family-owned stores.

Figure 2.2: Share of Different Segments in Organised Retail, 2007

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14.3 22.7
3.2 1.1

48.9 48.4

13.4
12.3
3.3 5.3
9.9 8
11

Clothing, textiles and fashion accessories

Food and grocery
Footwear
Consumer durables, home appliances/equipment
Out-of-home (catering) services
Furnishing, utensils, furniture-home and office
Mobile handsets, accessories and services
Entertainment
Jewellery
Books, music and gifts
Watches
Health and beauty care services
Pharmaceuticals

Source: Authors’ compilation from Images. 2009. ‘India Retail Report 2009’, Images F&R
Research, New Delhi, p. 79.

It is worth mentioning that India has low penetration of

organised retail in the food and grocery segment compared to most
emerging markets. In recent years, Indian corporates like Pantaloon
Retail Limited (Future Group) and Reliance Retail Limited (Reli-
ance India Company) have entered into food and grocery retailing.
 FDI in Sensitive Sectors •5 1

A number of foreign multi-brand retailers have shown an interest to

enter this segment of retail and some (such as Walmart and Tesco)
have set up operations through whole sale cash-and-carry.

Retail Policy in India

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India has a quasi-federal governance structure. The Constitution

of India has demarcated the areas of jurisdiction between central
government (Union List), state government (State List) and joint
administration of central and state government (Concurrent List).
The retail sector falls under the State List. However, different
departments of the central government, state government and
local/municipal bodies regulate retail.
At the centre, the Department of Consumer Affairs regulates
internal trade while the DIPP regulates FDI. Different ministries/
departments such as Ministry of Agriculture and the Ministry
of Textiles regulate specific products which has an impact on the
retailing of these products. The Shops and Establishments Act, under
the purview of the state governments, lays down the conditions for
establishing and operating retail outlets including shop opening
and closing timings. The state governments also regulate sourcing
(through Acts like Agricultural Produce Marketing Committee
[APMC] Act) and entry and movement of goods within state
boundaries. Zoning is under the purview of local municipal bodies.
The multiplicity of regulatory bodies has resulted in
a large number of laws and regulations relating to sourcing,
packaging, distribution, etc. The number of regulations and extent
of restrictions vary across states, and even cities, depending on the
type of retail formats and the commodities traded. On an average, a
corporate retailer has to obtain around 30 licenses and clearances.
This can increase to around 45 for segments like food and grocery
retailing (Joseph and Soundararajan, 2009). At present, there is
hardly any discrimination in terms of regulations between foreign
and domestic retailers, except for the FDI restrictions.
Foreign direct investment up to 100 per cent is allowed in
wholesale cash-and-carry through automatic route and for export
trading subject to the condition that wholesale of goods would
be permitted among companies of the same group provided it
does not exceed 25 per cent of the total turnover of the wholesale
venture. Foreign direct investment up to 100 per cent is allowed in
 52•Tanu M. Goyal and Arpita Mukherjee

franchising for the trading of items sourced from the small-scale

sector, test marketing, trading of items for the social sector, trading
of hi-tech, medical and diagnostic items, and domestic sourcing of
products for exports subject to the provision of the Export Import
policy.5 Domestic trading of products of joint ventures is permitted at
the wholesale level for such trading companies that wish to market
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manufacturers’ products on behalf of their joint ventures in which

they have equity participation in India. Foreign direct investment
up to 100 per cent is permitted for e-commerce activities. However,
these companies are only allowed to do business-to-business (B2B)
e-commerce and not retail trading. Foreign direct investment up to
100 per cent is allowed in manufacturing.
In 2006, the Indian government allowed only 51 per cent
FDI in ‘single-brand retailing’ subject to Foreign Investment Pro-
motion Board (FIPB) approval and certain conditions. In January
2012, the Indian government completely liberalised FDI in sin-
gle-brand retail subject to FIPB approval and the conditions that
(a) only single brand products will be sold (i.e., retailing of goods
of multi-brand even if produced by the same manufacturer will not
be allowed), (b) products should be sold under the same brand
internationally, (c) single-brand product-retailing covers only prod-
ucts which are branded during manufacturing, (d) any addition to
product categories to be sold under ‘single brand’ will require fresh
approval from the government, (e) the foreign investor should be the
owner of the brand, and (f) for FDI beyond 51 per cent, 30 per cent
sourcing from small- and medium-scale enterprises (SMEs) would
be mandatory. In November 2011, the Cabinet proposed to allow
FDI in multi-brand retail up to 51 per cent subject to certain condi-
tions: (a) minimum foreign investment should be US$ 100 million,
(b) at least 50 per cent of the total FDI should be invested in ‘backend
infrastructure’, (c) at least 30 per cent of the goods should be pro-
cured from SMEs, (d) foreign retailers can establish presence only
in cities with a population of more than 10 lakh as per 2011 Census
and may also cover an area of 10 kilometres around the municipal/
urban agglomeration limits of such cities, and (e) the government
will have the first right to procurement of agricultural products.
Although at present there are restrictions in FDI in multi-
brand retail, foreign multi-brand retailers can enter the Indian
market through various other routes some of which are listed in
Table 2.1.
 FDI in Sensitive Sectors •5 3

Table 2.1: Mode of Entry and Present Mode of Operation of

Selected Foreign Retailers

Foreign Mode of Entry Present Mode of

Retailer in India Operation in India
Bata Manufacturing Wholly-owned subsidiary
Ermenegildo Franchising and distribution Joint venture in single brand
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Zegna agreement retail

Giorgio Armani Joint venture in single brand Joint venture in single brand
retail retail
Mary Kay Test marketing Test marketing
Metro Wholesale cash-and-carry Wholesale cash-and-carry
Reebok Exclusive licensing agreement Wholly-owned subsidiary
Tesco Wholesale cash-and-carry Wholesale cash-and-carry
United Colors 50:50 Joint venture with Wholly-owned subsidiary
of Benetton cloth mill
Walmart Wholesale cash-and-carry Wholesale cash-and-carry
Source: Authors’ compilation from the survey.

Table 2.1 shows that the present FDI restriction is not an

entry ban, but it restricts the ability to enter through the most
preferred route. Moreover, each of these entry routes has certain
drawbacks. For instance, at present, most of the low-priced,
multi-brand retailers like Walmart and Tesco are entering through
the wholesale cash-and-carry route, which does not allow these
companies to make direct sales to consumers. Therefore, they
cannot reap the benefits of the large and growing Indian consumer
market. Moreover, wholesale cash and carry is a ‘volume’ business
and may not be suitable for specialised and luxury products which
are generally purchased in small quantities.6
Entry routes like franchising, licensing and distribution
arrangement do not allow foreign retailers to have a share in profits
in India. In addition, foreign luxury brands do not like to give away
their brand ownership to a number of distributors as it can act as a
deterrent to the global brand name.
Setting up a manufacturing facility requires investment,
long-term commitment and is only economically viable if there
is enough demand for the product. In India, setting up of manu-
facturing is not easy — companies have to adhere to the labour
laws and they often face infrastructure bottlenecks (such as power
 54•Tanu M. Goyal and Arpita Mukherjee

shortage). Therefore, most retailers prefer to source from contract

manufacturers.
The single-brand retail policy requires that the foreign
partner should be the original owner of the brand and not
distributors, dealers, etc., in order to ensure that the international
quality and standard of the product is maintained. Many
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international brands from Europe and the US are marketed

through dealers/distributors in the Asia-Pacific region. Further,
permission is granted only to those brands that are regular product
lines of foreign companies, which means that foreign companies
cannot experiment with new brands created exclusively for the
Indian market. If a foreign retailer has multiple brands, separate
permission for each brand is required to enter the Indian market.
Due to this, very few retailers have applied for entry through the
single-brand route since 2006. Some applicants like IKEA have
deferred their investment plans in India due to the investment
rules in India.
Between 2006 and December 2010, single-brand retail
trading received $229.12 million FDI (0.18 per cent of the total
FDI inflows). Till December 2010, the DIPP received around 100
applications for investment through the single-brand retail route.
Of these, 59 applicants were granted approval.7 Around 52 per
cent of the approved applications were in the branded clothing
and fashion accessories segment, followed by footwear and leather
products (8 per cent).
It is implicit from the nature of the applications received
and approved that single-brand retail liberalisation has benefitted
foreign retailers in the luxury and specialised product segments
such as clothing, fashion accessories and jewellery.
Until recently FDI was prohibited in multi-brand retail.
Although the government proposed to allow partial FDI in multi-
brand retail there are several restrictive conditions. For instance,
the retailers have to procure a certain quality from SMEs. While this
may not be a constraint for food and grocery retailers it can be a
constraint for luxury multi-brand retailers. Similarly the minimum
capital requirements and requirements to invest in the supply chain
can be restrictive. Retailers often outsource their supply chain and
backend infrastructure to established logistics service providers.
It is important to mention that the restrictions on FDI in
multi-brand retail are compelling foreign retailers to enter India
 FDI in Sensitive Sectors •5 5

through other routes. For instance, Finnish mobile retailer Nokia

has entered India through the wholesale cash-and-carry route.
Most foreign direct selling companies also take the wholesale route
to enter the Indian market which is unlike their global operations.

Global Retail Regulations

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Globally, retail is a highly regulated sector. However, with

liberalisation, most countries now permit foreign investment in
retail. The process of liberalisation in emerging markets started
in the 1990s with China opening its retail sector in 1992, Brazil,
Mexico and Argentina in 1994 and Indonesia in 1998 (Mukherjee
and Patel, 2005). The opening up of the retail sector was an
important component of China’s WTO accession commitments.
There is hardly any country with a brand-based FDI policy like
India.
Many countries (including China) have opened up the
retail sector in a phased manner. Japan first allowed FDI in specific
retail formats such as speciality stores and then gradually allowed
it in hypermarkets and supermarkets. In some countries, FDI in
retail is allowed subject to certain conditions such as partnership
and investment requirements. For instance, in Sri Lanka, FDI is not
permitted in retail trade for investments of less than $1 million
(or $150,000 in the case of international brands and franchises).
In the Philippines, foreign investment in retail enterprises is
permitted if it meets several requirements such as minimum level
of paid-up capital, investment per store and net worth. The retailer
must own at least five retail stores elsewhere or at least one outlet
with a capitalisation of $25 million or more. For retailers of high-
end or luxury products the conditions are more stringent and
there is a local sourcing condition. Moreover, in the Philippines,
retail enterprises with foreign ownership exceeding 80 per cent
of equity must offer at least 30 per cent of their shares to local
investors within eight years of the start of operations through a
public offering.
Apart from FDI restrictions countries have imposed several
regulations that can vary across regions within the same country.
For instance, countries like Japan, China, Singapore, Italy, and
France impose zoning restrictions on retailers. Zoning is often a
 56•Tanu M. Goyal and Arpita Mukherjee

part of urban planning, but it may restrict the location of organised

retailers and/or shopping malls. While in most countries these
restrictions are common for both foreign and domestic retailers, in
some cases, they are imposed only on foreign retailers. In China,
for example, domestic companies are treated more favourably than
foreign companies in zoning and urban development requirements
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(USTR, 2010). In France and Vietnam there is an economic need

test (ENT) which examines the requirement for a retail outlet.
In Singapore, initially the government allowed only tra-
ditional retailers to locate in the city centre. But due to massive
congestion, the government instituted a major land-use policy that
provided incentives, mixed with zoning rules, for hawkers, small
shops, and wet markets to move to the suburban areas and super-
markets to grow in the central areas. The government provided
cash grants to traditional retailers for whom the transition to other
employment was not profitable. In the Philippines, foreign retail-
ers are prohibited from engaging in trade outside their accredited
stores, such as through the use of carts, sales representatives or door-
to-door selling.
In Japan, there is a law concerning the ‘Adjustment of Retail
Business Operations of Large-Scale Retail Stores’.8 The law regulates
the operation of organised retail outlets in order to ensure that the
small- and medium-scale retailers operating within the vicinity of
large enterprises enjoy reasonable opportunities for business.
Some countries require foreign retailers to source locally
or enter in partnership with domestic enterprises. For instance,
in Indonesia, even though 100 per cent foreign equity is allowed
in the distribution and retail sectors, investors must enter into a
‘partnership agreement’ with a small-scale Indonesian enterprise.
In the Philippines, at least 30 per cent of inventory, by value, must
be sourced locally.
In some countries, foreign retailers face product-specific
restrictions. For instance, in Vietnam, foreign-invested distributors
are restricted from trading in certain goods that are excluded from
Vietnam’s WTO Schedule of Specific Commitments such as videos
(tapes, VCDs, DVDs) and pharmaceuticals. In Ethiopia, foreign
investors are not allowed to invest in a wide range of small retail
and wholesale enterprises (e.g., printing, restaurants and beauty
shops). Sales of pharmaceuticals, health products and tobacco and
alcoholic beverages are regulated across the world.
 FDI in Sensitive Sectors •5 7

Some countries have stringent labour-related regulations

which may impact the operation of foreign retailers. In Bolivia,
foreign employees are restricted to 15 per cent of the workforce
and only as technical staff. Countries such as Nigeria, Qatar and
France have local employment requirements and in Austria, the
Czech Republic, France, Hungary, Italy, and Korea, there are
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nationality requirements.
Some countries have also implemented regulations to
support the growth of domestic small and medium retail. In 1992,
the Singapore government launched a programme to upgrade
small/unorganised retailers by offering financial assistance and
training. It also encouraged small retailers to form shop-owner
associations (buying cooperatives) and purchase products in bulk
to lower costs. Some countries like Thailand liberalised in a hasty
manner and then started implementing regulations to protect the
domestic retailers.
The global experiences show that appropriate regulations
rather than FDI restrictions have been used as a tool to regulate
the retail sector. This allows inflow of foreign investment technical
know-how and skills and at the same time enables the countries to
control and monitor large/foreign retailers.

Literature Review and Existing Views on FDI

Foreign direct investment in retail is a politically sensitive issue in
India. In the early stages of the growth of organised retailing, some
Indian corporates were in favour of FDI while others opposed it.
Policy makers, academicians, industry experts, media, and other
stakeholders have contributed to this debate. Most of the views
are based on perceptions while only some are based on academic
research.
One of the earliest survey-based academic works on FDI
in retail sector was that of Mukherjee and Patel (2005) which
found that FDI restriction is not an entry ban and the impact of
FDI in retail is largely positive. The study highlighted that since the
Indian economy is growing at a fast pace, both the organised and
unorganised retail sectors will grow. Foreign direct investment will
lead to inflow of technology, skill development, brand building and
streamlining the supply chain. The authors recommended that FDI
 58•Tanu M. Goyal and Arpita Mukherjee

in retail should be allowed in a phased manner, starting with 49

per cent. A study by Joseph and Soundararajan (2009) found that
the negative impact of organised retail on the unorganised sector
(if any) exists only in the short run but it wears off with time.
Singh (2010), based on the survey of global and Indian
experiences, highlighted some of the negative impacts of organ-
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ised retail including the malpractices due to buying power, loss

in employment in the supply chain due to the removal of inter-
mediaries and reduction in risk sharing with farmers. The author
recommended slowing down of supermarket expansion by using
mechanisms such as zoning, business licences and trading restric-
tions. An Economic and Political Weekly editorial in 2007 critically
evaluated the pros and cons of multi-brand retail liberalisation and
concluded that liberalisation with the right regulation is needed.
Guruswamy et al. (2005) highlighted the role of public policy in
helping the traditional retailers. Sarma (2005) emphasised that
the government should examine constraints faced by the tradi-
tional retailers and other players in the supply chain and institute
safety nets as has been done in other Asian economies.
The DIPP discussion paper on FDI in multi-brand retail
has further stimulated the FDI debate. Over 110 individuals and
entities submitted their responses to this discussion paper—both in
favour of and against FDI in multi-brand retail. Some respondents
also listed the conditions that can be imposed on foreign retailers in
case FDI is allowed in multi-brand retail. However, these concerns
are mostly related to all organised retailers and not specifically to
foreign retailers.
A number of Indian manufacturing, trade and small
retailers’ associations have expressed reservations against FDI in
retail. Out of a total of 80 domestic manufacturing and trading
associations that have responded to the DIPP discussion paper, 73
have raised concerns against FDI. Of these, 48 are responses on the
letter heads of different associations from the state of Tamil Nadu.
They claim that organised retailers will endanger the livelihood of
those directly and indirectly engaged in retail trade. It may lead to
predatory pricing and oligopolistic market conditions with a few
organised retailers holding a major share in the Indian market.
They argue that most organised retailers procure from farms
without entering into formal contracts with farmers, which can
be a deterrent to small farmers. Interestingly, it was later found
 FDI in Sensitive Sectors •5 9

during the survey that some of these associations like the South
India Hosiery Manufacturers Association have members who are
actively engaged in exports and cater to foreign brands such as
Tommy Hilfiger. While the presence of foreign retailers in India
can increase sourcing from these manufacturers, it is difficult to
understand why such organisations are opposing FDI in retail.
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Pan-India industry chambers such as the Federation of

Indian Chambers of Commerce and Industries (FICCI) and the
Confederation of Indian Industry (CII), Retailers Association of
India (RAI), foreign retailers and Indian corporates, companies
in allied sectors and academicians have responded in favour of
FDI in retail. They have highlighted that organised retail will
generate efficiencies in distribution, provide a respectable working
environment to the masses, create employability of under-
privileged youth and help in developing both front-end and back-
end retail operations.
Some of the respondents in favour of allowing FDI in retail
have also made certain suggestions on the operating conditions for
organised retail. Some of these are:
(a) There should be a clear definition of the different retail
formats — hypermarkets, supermarkets and departmental
stores.
(b) Since food retailing is sensitive, the food and non-food
sector should be dealt with separately — both in terms of
the FDI policy as well as in terms of back-end investment
requirements.
(c) There should be zoning restrictions and domestic sourcing
conditions.
(d) The government should formulate a proper anti-competi-
tive policy. There can be a comprehensive National Retail
Act which will be a model regulation. Some respond-
ents emphasised the need for a regulator to facilitate the
growth of this sector.
(e) There is need for manpower training for catering to the
requirements of organised retail.
Overall, the views of whether FDI should be allowed in
retail vary across stakeholders and given the multifaceted opinions
on FDI in retail it is difficult to reach a consensus. Some important
stakeholders, such as consumers and employees of retail outlets,
 60•Tanu M. Goyal and Arpita Mukherjee

who are directly affected by the FDI policy, have not responded to
the DIPP discussion paper.

Survey Design and Research Methodology

To understand the views of different stakeholders on FDI in
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retail, the Indian Council for Research on International Economic

Relations (ICRIER) conducted a pan-India pilot survey in 2009–10
of around 1,000 stakeholders including unorganised retailers,
supply chain agents, manufacturers, trade associations, employees
of the retail outlets, and consumers through face-to-face interviews.
The sampling frame which is given in Table 2.2 was designed to
include all stakeholders who are likely to be impacted by the FDI
decision.

Table 2.2: Sampling Frame

Category Number
Unorganised Retailers 254
Organised Retailers 78
Domestic Retailers 50
Foreign Retailers 28
Employees of Retailer Outlets 200
Organised Retail 80
Unorganised Retail 120
Supply Chain Agents 100
Manufacturers 96
Association and Trade Union 40
Consumers 300
Total 1,068
Source: Primary survey conducted by Indian Council for Research on International Economic
Relations (ICRIER), 2009–10.

The sample of unorganised and organised retailers, supply

chain agents, manufacturers, trade associations, and employees
of the retail outlets was chosen using the random sampling
technique. Consumers were selected using the stratified-random
sampling technique. The entire population was stratified on the
basis of their income, occupation and education. Respondents
were largely selected from the middle and upper-middle income
 FDI in Sensitive Sectors •6 1

groups in socio-economic classification (SEC) A, B and C category.9

This is because these categories include consumers who are aware
and brand conscious and have suitable knowledge to respond on
foreign retailers and brand-related questions.
The survey was conducted in 13 Tier I, II and III cities.10
Only those cities were selected in which organised retailers are
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present or are planning to locate. Though a large percentage of

the Indian population resides in rural areas, the survey was not
conducted in rural areas since the penetration of organised retail
is limited.
The survey was conducted using semi-structured question-
naires with separate questionnaires for each of the stakeholders. A
part of the questionnaire was kept open-ended to obtain detailed
responses from the respondent. The key research objective was to
obtain the perceptions about organised retail outlets and FDI in
retail in particular.
The questionnaire for unorganised retailers enquired about
their business and operating model, sourcing patterns, customers,
and the services they provide; whether they are located in the vicin-
ity of organised retail outlets; the impact of retail modernisation on
their turnover; barriers faced in operations; their key competitors,
future expansion plans and their views on FDI in retail.
Employees of retail outlets (organised and unorganised)
were asked about their educational qualification and years of
experience. They were also asked questions to assess the quality of
employment in the outlets which included questions on their sala-
ries, training, increments, and incentives. Questions were asked
on their job prospects, knowledge and scope of foreign brands in
India, perceptions about FDI, etc. Employees from unorganised
retail were asked additional questions on their prospects in the
organised retail sector.
Manufacturers, supply chain agents and associations were
asked about effects of organised retail, their clientele and their
perception on FDI in the retail sector.
The consumers were asked about their shopping behav-
iour including information about the products they purchase,
branded and non-branded product purchases, whether they buy
from organised retailers or traditional outlets and the prices that
they are willing to pay. They were also asked about the impact
of organised retail outlets on their consumption patterns, benefits
 62•Tanu M. Goyal and Arpita Mukherjee

and drawbacks of organised retailers and in particular, foreign

retailers and brands. Lastly, they were asked about their perception
on whether FDI should be allowed in the retail sector.
The data have been analysed by using quantitative and
descriptive tools.
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Survey Findings
Some of the key survey findings are discussed in the following
paragraphs.

Retailers’ Survey
The unorganised retailers’ survey found that the majority of
them cannot distinguish between an Indian corporate retailer, a
franchisee of a foreign brand and a foreign retailer. Hence, their
responses are related to the impact of organised retail outlets on
their business rather than on the impact of FDI in retail. The impact
was assessed separately for those who have and those who did
not have an organised retail outlet in their vicinity. One hundred
and thirty unorganised retailers had organised retail outlets in
their vicinity. Of these, around 40 per cent pointed out that they
have been negatively affected by the presence of organised retail
outlets but only 23 per cent experienced a decline in their profits
since 2007. The negative effect was primarily due to the increased
competition from organised retail outlets. Interestingly, 80 per
cent of these 130 unorganised retailers also faced competition
from other unorganised retailers. Some unorganised retailers
pointed out that the impact of organised retail was positive as the
number of customers in their location has increased leading to an
increase in business. They also pointed out that loyal clientele and
personalised services such as sale on credit have helped them to
face competition. Only one among 124 unorganised retailers who
did not have organised retail outlets in their vicinity said that he was
adversely affected by organised retailers. All the 254 unorganised
retailers were asked if any shops in their neighbourhood were
closing down and the reasons for this. Only 5 per cent said that
shops were closing due to competition. Some shops had closed
 FDI in Sensitive Sectors •6 3

down due to internal management problems and the inability to

provide good quality products to the customers.
Both organised and unorganised retailers were asked
about the most important barriers that they are facing. This was
a multiple-choice question and a five-point Likert scale was used
to rank the barriers where 1, 2, 3, 4, and 5 represented ‘very low’,
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‘low’, ‘average’, ‘high’ and ‘very high’, respectively. Table 2.3 shows
the percentage of responses calculated on the basis of ranking of
barriers as ‘high (4)’ and ‘very high (5)’. Infrastructure bottlenecks
seem to be the most important barrier for both organised and
unorganised retailers. Unorganised retailers referred to competition
from shopping malls and not specifically organised retailers as
an important barrier. This is because they felt that some of the
infrastructure problems are solved by the shopping malls.

Table 2.3: Top 10 Barriers Faced by Unorganised and Organised Retailers

Barriers for Barriers for

Rank Percentage Percentage
Unorganised Retailers Organised Retailers
1 Inadequate/congested 41.7 Electric shortage 43.6
parking facility
2 Competition from 12.2 Inconvenience regard- 11.5
shopping mall ing shop opening time
3 Taxes are high 11.0 Shop lifting/poor 10.3
security
4 Electric shortage 10.2 High cost of infra- 7.7
structure
5 Low customer 7.9 Taxes are high 5.1
turnover
6 Prices have fallen 5.5 Low customer turnout 3.8
on specific occasions
7 Unavailability of 4.7 Presence of local taxes 3.8
finance
8 Presence of local 4.3 Trade union problem 2.6
taxes
9 High cost of infra- 3.5 Multiple regulation 2.6
structure
10 Local municipal 3.1 Absence of mature 1.3
problem third party logistic
Source: Authors’ findings from the primary survey.
 64•Tanu M. Goyal and Arpita Mukherjee

Based on the ranking of barriers it is clear that (a) retailers

(whether organised or unorganised) in India face similar barriers,
and (b) if some of these, such as infrastructure-related barriers are
addressed, unorganised retailers would be in a better position to
handle competition from organised retailers.
The survey found that many Indian corporates have
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entered the retail business in recent years. They are new to this
business and are learning from global best practices. Due to this,
a majority of them have entered or have shown an interest to
enter into collaborations with foreign retailers. Such partnerships
help the Indian corporates to share the initial start-up cost with
foreign retailers and it has provided them access to international
technology and global management best practices. Foreign
retailers, on the other hand, get local market knowledge and
therefore, they too have expressed interest in joint ventures.
Interestingly, a majority of the foreign retailers pointed out that
the FDI restriction is not an entry ban but their entry route is not
clear which leads to operational uncertainty. In 2010, the DIPP
has changed the definition of wholesale trade which has further
increased the uncertainties. Foreign retailers also pointed out that
in certain segments such as food and grocery, significant back-end
investment is required and profits can be reaped with a gestation
lag. They would do the back-end investment and source from Indian
SMEs whether a condition is imposed or not. However, companies
argued that they are in the best position to decide what part of the
investment will be in back-nd infrastructure. In the initial stages
more investments are needed in back-end infrastructure which
phase down over time once the infrastructure is in place. Overall,
transparent policy and operational stability is crucial for making
such investments. Otherwise, India will not get investments in the
supply chain.

Employees of Retail Outlets

The employee survey shows that across the same skill level
the salaries in the organised sector are higher, there are more
possibilities of increment and incentives (Figures 2.3a and 2.3b).
Incentives in organised outlets are performance linked and there
are more opportunities of training and skill development (Figures
2.4a and 2.4b).
 FDI in Sensitive Sectors •6 5

Figure 2.3: Average Salaries and Other Benefits across Organised and
Unorganised Retail Outlets

(a) Average salaries of store help across qualification

and experience (in rupees)
8000
6750
7000
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6200
6000
5000
5000 4500

4000
3000
2000
1000
0
Modern retail Traditional retail Modern retail Traditional retail
outlet outlet outlet outlet

Less than 5 year sexperience 5–10 years

Up to class 12th Degree graduate

(b) Increments and incentives

90.00
80.77
80.00
70.00
58.82
60.00
50.00
40.00 35.29
30.00
19.23
20.00
10.00 5.88
0.00
0.00
Yes No No response

Percentage organised Percentage unorganised

Source: Authors’ findings from the primary survey.

 66•Tanu M. Goyal and Arpita Mukherjee

Figure 2.4: Percentage Distribution of Employees Receiving Trainings and

Outlets Imparting Training

120.00 (a) Training and skill development

100.00 96.15
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80.00
58.82
60.00
41.18
40.00

20.00
3.85
0.00
Modern Traditional

Percentage
Yes No

(b) Outlets imparting training

100.00 93.59
90.00
80.00
70.00
60.00 54.72
50.00
40.00 36.61

30.00
20.00
6.41 8.66
10.00 0.00
0.00
Yes No Not applicable
Modern retail outlet Traditional retail

Source: Authors’ findings from the primary survey.

Thus, overall the survey found that employment conditions

in organised retail outlets are better. The employees were also
asked about their long-term and short-term job prospects (see
 FDI in Sensitive Sectors •6 7

Figures 2.5a and 2.5b). Since the retail sector is growing, overall
the job prospects in retail are good, but they are better for organised
retail.
Figure 2.5: Long-term and Short-term Job Prospects in the Retail Sector

(a) Long term prospects in retail sector (in %)

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90.00
80.00 76.92
70.00
60.00
50.00
40.00 35.29 35.29
29.41
30.00
20.00 15.38
10.00 3.85 0 3.85 00.00
0.00
Very good Good Moderate Bad Very bad
Modern Traditional

(b) Short term job prospects (in %)

70.00 64.71 61.54

60.00

50.00

40.00
29.41
30.00 26.92

20.00
5.88 7.69
10.00
3.85 0 00.00
0.00
Very good Good Moderate Bad Very bad

Modern Traditional

Source: Authors’ findings from the primary survey.

Around 65 per cent of the unorganised sector employees

pointed out that they would like to work in the organised retail
 68•Tanu M. Goyal and Arpita Mukherjee

outlets due to higher salary and better employment conditions.

This explains why a majority of them saw good long-term
prospects in the industry. However, Figure 2.6 shows that the
transition from unorganised to organised retail is not very smooth,
primarily because the skill requirements in the two segments are
different. There is need for some training and skill upgradation of
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unorganised sector employees before they can be absorbed by the

organised sector.

Figure 2.6: Distribution of Respondents Who Have Tried Working in

Organised Retail Outlets (in Percentage)

Yes, I have tried but I did not

46.15
get opportunity

No, I did not try but I think

34.62
there are opportunities

Yes, I tried and I got some 11.54

opportunity

No, I did not try and do not know

7.69
about the opportunities

Yes, I tried and I got many 0

opportunity

0 10 20 30 40 50
Percentage

Source: Authors’ findings from the primary survey.

Overall, the survey found that the retail boom has created
job opportunities in this sector. Employees (in both the organised
and unorganised sector) pointed out that the Indian market is not
saturated and there is scope for further retail penetration. However,
the survey participants did not have much knowledge about the
impact of allowing FDI in retail. A majority (58 per cent) did not
answer this question. Among the rest, 73 per cent pointed out that
FDI should be allowed in retail as it will enhance opportunities
for retail employees. The remaining were against FDI as they felt
 FDI in Sensitive Sectors •6 9

that it could uproot unorganised retailers and lead to organised

retailers’ monopolistic position.

Manufacturers
A majority of Indian manufacturers are contract manufacturers for
domestic or foreign brands. Around 61 per cent of the respondents
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said that the growth of organised retail has benefitted them.

They ascribed their growth to various factors, some of which are
summarised here.

INCREASE IN THEIR BUSINESS

With the growth of organised retail, consumers are exposed to more
variety. There is an increase in brand awareness among consumers
due to advertising and product promotion strategies of organised
retailers. The growth of organised retail has propelled consumerism
which has led to an increase in business for manufacturers. Since
many organised retailers are sourcing locally, a large number of
manufacturers have increased their scale of operation to meet
increased demand.

NEWER OPPORTUNITIES
In order to reap benefits of low-cost production, a large number of
foreign retailers are sourcing their products locally not only for the
Indian market but also for exports. This is generating opportunities
for contract manufacturing for foreign brands. The presence of
foreign retailers has also brought their clients closer and Indian
manufacturers are now better equipped to understand their client’s
requirements.

IMPROVED QUALITY OF PRODUCTION

With the advent of foreign retailers there has been percolation of
technical know-how and the quality of production has improved.
Most foreign retailers invest in technology and have stringent
quality standards. Indian manufacturers benefit as they are exposed
to new techniques of production and packaging and are helped in
brand development.
Overall, around 64 per cent of the manufacturers are of
the opinion that the government should allow foreign retailers
in the Indian market, as it will contribute to their growth. The
 70•Tanu M. Goyal and Arpita Mukherjee

survey also found that the 2006 policy of allowing partial FDI in
single-brand retail has not benefitted the Indian manufacturers.
Only a few brands like Marks & Spencer are now sourcing from
India. The high-end luxury brands which have entered the Indian
market through this route are largely importing their products.
Manufacturers in certain product categories such as textiles and
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apparels and food processing pointed out that they would benefit
more if FDI is allowed in multi-brand retail.

Supply Chain Agents

The survey of wholesalers and distributors (a total of 40) found that
a majority of them could not assess the impact of organised retail
on the supply chain. Those who could (around 28 per cent) were
in favour of FDI in retail and said that FDI will lead to investment
in the supply chain.
Seventy-two per cent of the importers (a total of 30) were
of the opinion that FDI should be allowed in the retail sector as
it can lead to more imports of foreign brands. It will also lead
to increased knowledge about foreign brands and contribute to
the growth of the Indian market. Those against FDI in retail said
that Indian importers may become more dependent on foreign
companies. The buying houses (a total of 30) were in favour of
allowing FDI in retail since they felt that this will lead to increase
in their business and foreign retailers will source a substantial part
of the products locally. They argued that Indian consumers are
price conscious and designs, etc., have to be customised. Hence,
local sourcing will increase.

Associations and Export Councils

The export councils interviewed work closely with the government
to promote exports and attract FDI in their respective sectors.
Councils in sectors such as textiles and leather products pointed out
that India has raw materials and labour but lacks technology and
investments. They argued that FDI and technology transfers from
foreign retailers will lead to development of brands, improvement
in quality and designs. The presence of foreign retailers in India
has helped their members to enhance productivity and upgrade
their technology.
 FDI in Sensitive Sectors •7 1

Consumers
The survey of consumers found that a majority of the expenditure
is on food and grocery, followed by clothing and accessories. For
certain product categories such as fresh fruits and vegetable and
furniture, consumers buy largely non-branded products while they
buy both branded and non-branded products for categories like
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footwear, apparel and jewellery. Branded products are largely

purchased in segments like consumer durables and watches. The
purchase behaviour to a certain extent depends of the availability
of brands. For example, in India there are few brands in fresh
fruits and vegetables. When asked about where they made their
purchases, consumers gave mixed responses. A majority of the
consumers bought fresh fruits and vegetables from unorganised
retail outlets (see Table 2.4).

Table 2.4: Percentage Distribution of Respondents as per their

Source of Purchase for Different Product Categories (in Percentage)

Unorganised Organised
Product Category Both
Retailers Retailers
Fresh fruits and vegetables 91.3 7.3 1.3
FMCG products 86.0 13.3 0.7
Preserved food and agro products 82.0 17.6 0.4
Jewellery 32.3 63.9 3.9
Handbags 35.2 63.5 1.3
Apparel 1.0 67.3 31.7
Footwear 1.0 89.7 9.3
Source: Authors’ findings from the primary survey.

When asked about comparison between organised and

unorganised outlets, the consumers found organised retail
outlets better in terms of store operators, infrastructure and
location. However, they still prefer the unorganised outlets in
terms of the ability to bargain and the price of the products (see
Figure 2.7). Given that in general Indian consumers are price
conscious, this is an important advantage of the unorganised
retail sector.
 72•Tanu M. Goyal and Arpita Mukherjee

Figure 2.7: Consumers’ Ranking of Various Parameters in

Organised Retail Outlets

Store operators 94
Infrastructure 93
Location 90
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Availability of products 90
Connecting roads 89
Overall performance versus small retailers 87
Availability of public transport 87
Parameters

Public utilities (toilets) 85

Shop opening time 84
Time taken in clearing bill 68
Technical problems (bar codes, cash
counter machines, etc.) 64
Reach distance and time 61
Ease in getting things exchange/returned 55
Parking facility 54
Prices of products 52
Ability to bargain 4

0 20 40 60 80 100
Percentage

Source: Authors’ findings from the primary survey.

When asked if FDI should be allowed in retail, around 83

per cent of the survey respondents responded in favour of allowing
FDI in retail. Some of the reasons given in favour of allowing FDI
in retail are summarised here:

GREATER VARIETY AND IMPROVED KNOWLEDGE

By allowing foreign retailers, Indian consumers will be exposed
to more variety of products and brands, particularly in segments
where there are very few domestic brands. This will lead to
improved knowledge and awareness about internationally used
products and brands.

BETTER QUALITY
Foreign brands are generally perceived to be of better quality. This
is true in product segments like beauty products and cosmetics.
 FDI in Sensitive Sectors •7 3

The survey respondents claimed that this will instil competition

and Indian brands will also improve their quality standards.
IMPROVE ACCESS TO BRANDS
Indian consumers are gradually becoming brand conscious and they
pointed out that foreign retailers in India can lead to improved access
to brands. A number of consumers have been buying foreign brands
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during their international travel, which they can now access easily.

BENEFICIAL FOR ORGANISED RETAIL GROWTH

The survey respondents claimed that foreign investments will lead
to the growth of organised retail, which will benefit the overall
retail sector as Indian retailers will be exposed to foreign best
management practices.

IMPROVED PRICES
Some consumers pointed out that foreign retailers and organised
retailers will help in bringing down prices, especially for mass
market products. This is because they cut down the number of
intermediaries and streamline the supply chain. Others pointed
out that price reduction will take place due to higher competition.
Those against allowing FDI in retail pointed out that
foreign brands are costlier and they cater to people in the high-
income category. Foreign retailers can adversely affect domestic
retailers, the Indian market is already saturated and there is limited
scope for accommodating more brands.
The survey results showed that consumers’ attitude
towards foreign brands is positively correlated with their educa-
tional qualification. Figure 2.8 shows that respondents with higher
education favoured FDI in retail implying that as Indian consumers
become more educated they are likely to have a positive attitude
towards allowing FDI in retail.
The single-brand policy of 2006 was enacted to give
Indian consumers access to foreign brands and imported
products. However, the survey revealed that although access
and availability of brands have increased, the single-brand FDI
policy has not significantly benefitted the Indian consumers. Only
luxury brands in a few product categories have entered the Indian
market through this route. The import duties in India are high
and hence branded products in India have a much higher price
than abroad. The per capita income in India is lower compared to
western markets; therefore the ability to buy high-priced luxury
 74•Tanu M. Goyal and Arpita Mukherjee

Figure 2.8: Distribution of Respondents in Favour of

FDI by their Educational Qualification

100
88.62
90
80.63
80 72.73
70
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60
50
40 33.33
30
20
10
0
Schooling Some college but Graduate Post graduate
not graduate
Percentage in favour of FDI

Source: Authors’ findings from the primary survey.

brands is limited. Moreover, knowledge about luxury brands is

still limited in India.

What Should be the FDI Policy?

The discussions in the previous sections show that retail is one of the
fastest growing sectors in India. It is also one of the largest employers
providing self-employment opportunities to a large number of people,
particularly in the traditional sector. As the Indian economy is growing
and per capita income is rising, the retail sector is likely to grow in
the future. Modernisation of retail is a part of the overall growth and
development process of India. The speed of modernisation can be
affected by government regulations and the FDI policy. The issue of
allowing FDI in India has been widely debated and views both within
the government and outside are divided.
India has partially allowed FDI in single-brand retail
in 2006. In 2011 a further liberalisation of the retail sector has
been proposed. Although the country is one of the most attractive
destinations for global retailers, partial liberalisation of single-
brand retail has not been successful is attracting significant FDI.
The government is now proposing the liberalisation of multi-brand
retail subject to certain conditions.
 FDI in Sensitive Sectors •7 5

While the government argues that liberalisation of retail

will lead to back-end investment, job creation, FDI inflows and
reduction of inflation, opponents of the policy argue that it will
have an adverse impact on employment. The existing literature
suggests that the views on FDI in retail are both positive and
negative. The survey conducted by ICRIER found that although the
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opinions vary, a majority of the survey respondents are in favour

of FDI in retail.
The survey found that a majority of the unorganised
retailers cannot distinguish between domestic and foreign
organised retailers hence the issue is not foreign versus local
players but big versus small players. Competition from large
players has been one of the key concerns. However, other barriers
such as poor infrastructure are a bigger impediment to operations
of unorganised retailers than competition from organised retail.
In fact, infrastructure is a core problem for both organised and
unorganised retailers. To protect unorganised retailers, India can
implement zoning regulations as in other countries, highlighting
the requirement of urban planning. The government can initiate
policies like Singapore, which supports growth of unorganised
retailers, and increase their competitiveness rather than restricting
the expansion of organised retail.
The survey found that salaries and working conditions in
organised retail outlets are better. The skill levels in traditional
and organised retail are different and, hence, it will not be easy
for employees to shift between these two kinds of outlets. In
order to enhance the employability in the organised retail sector,
the government should have policies directed towards imparting
soft skills and training to unorganised retail employees. The state
government can work with retailers and educational institutes to
design retail courses through public–private partnership, which
will upgrade the skills of employees in traditional retail and create
new employment opportunities.
The majority of the manufacturers and consumers are in
favour of allowing FDI in multi-brand retail. However, these two
groups have not benefitted much from the partial liberalisation
of the single-brand retail in 2006, which led to the entry of
luxury brands. Some of the advantages of allowing FDI in retail
include increased inflow of capital and technology, investments in
supply chain, improved opportunities for skill development and
 76•Tanu M. Goyal and Arpita Mukherjee

employment within the retail sector, reduction in intermediaries,

greater choice, awareness, exposure, and improved quality of
products for consumers.
The survey found that the FDI restriction on multi-brand
retail is not an entry ban but inhibits the ability of foreign retailers
to choose their most preferred route of operation. Even if FDI is not
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allowed in multi-brand retail, foreign retailers can enter the Indian

market through other routes such as franchising, distribution,
wholesale cash-and-carry and licensing agreements. The restriction
on FDI has led to multiple, non-transparent entry routes creating
operational uncertainty. There is need for a transparent FDI policy.
For this, retail and wholesale trade has to be clearly defined as
per the international definition. Instead of a case-by-case approval
process there should be a clearly defined FDI policy.
Globally, the retail sector is regulated and there is need
for regulating the sector in India too. Regulations are needed
to monitor the organised retailers and support the growth of
unorganised retailers. However, the FDI restrictions should be
delinked from regulation. A major problem of the retail sector is
that there is no governing ministry for retail at the centre. There is
need for a nodal ministry at the centre. Multiplicity of regulatory
bodies has resulted in multiple and complex regulations. There is
a need for streamlining of domestic regulations. For example, the
centre can come up with a model Shop and Establishment Act and
states can then adhere to this model Act.
Since the present FDI restriction is not an entry ban, a
number of survey participants said that they can benefit from
allowing FDI. The Indian government should allow FDI in multi-
brand retail in a phased manner giving the domestic industry time
to adjust. To begin with, FDI up to 49 per cent can be allowed
in multi-brand retail. This will enable domestic industry to enter
into joint ventures with foreign companies leading to inflow of
technical know-how and skills.
Some of the responses to the DIPP consultation paper
suggested that while formulating the FDI policy, sensitive product
segments like food and grocery can be dealt with separately from
non-sensitive segments such as apparel retailing. The government
may explore the possibilities of allowing FDI in multi-brand retail
in less sensitive retail segments like apparels, sportswear, consumer
 FDI in Sensitive Sectors •7 7

durables, etc., and then open up sensitive sectors. Although this

will address the issue of political sensitivities linked to allowing
FDI in retail, it may not help in streamlining the fragmented supply
chain, especially in the food and grocery segment.
Some countries have imposed sourcing conditions.
The survey found that for catering to local taste and meeting
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the demand of price-sensitive consumers most of the existing

organised retailers in India (both Indian and foreign) source
locally. Hence, there is no need to impose a sourcing condition.
If a condition on sourcing from SMEs is imposed it may adversely
impact expansion of scale of production. In the past reservations
of products for the small-scale sector have adversely affected the
growth of manufacturing. If any sourcing condition is imposed,
it has to be consistent with India’s commitments under the Trade
Related Investment Measures (TRIMs) agreement of the WTO.
One of the key concerns of expansion of organised
retailing is anti-competitive practices by large players. These can
be restricted by a proper anti-competitive act. The Competition
Act, 2002 has provisions to check the abuses of the dominant
position of major players including predatory pricing. In the Indian
Competition Act, dominant position is defined as ‘a position of
strength, enjoyed by an enterprise, in relevant market, in India’.11
However, the dominant position has to be clearly specified, in terms
of the market size of the retailers, like in the case of countries like
Australia.
Overall, appropriate regulation rather than FDI restriction
will help to minimise the negative impact, if any, on unorganised
retailers and help the retail sector to grow.

Notes
1. Calculated from World Economic Outlook Database, April 2010, IMF
(GDP is at 1999–2000 prices), [Link]
ft/weo/2010/01/weodata/[Link] (accessed 10 February 2012).
2. Single-brand retailers are those that have a single (or one) brand un-
der the retail chain. Multi-brand retailers house more than one brand.
Most corporate retailers are multi-brand retailers.
3. MOSPI (2010). Figures are at current price.
 78•Tanu M. Goyal and Arpita Mukherjee

4. All dollar figures are in United States (US) dollars. See A. T. Kearney
(2010).
5. In the case of franchising FDI (unless otherwise prohibited) is al-
lowed with the approval of the Reserve Bank of India. Trading in the
small-scale sector is with FIPB approval. Test marketing is a limited
introduction of a product or service to test public reaction for a full
market strategy. In India, the DIPP has permitted test marketing of
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such items for which a company has approval for manufacture, pro-
vided such a test marketing facility will be for a period of two years,
and investment in setting up the manufacturing facility commences
simultaneously with test marketing.
6. The route permits only business-to-business operations where goods
are generally sold in bulk.
7. As per the information given by Foreign Investment Promotion Board
(FIPB), India.
8. See [Link] (accessed
15 July 2011).
9. SEC is based on occupation and education of an individual. For de-
tails, see Table A1 in Appendix A.
10. Tier I cities include Delhi, Mumbai, Kolkata, Chennai, Pune, Hydera-
bad, and Bangalore. Tier II cities include Surat, Meerut and Agra and
Tier III cities include Bhubaneswar, Jalandhar and Amritsar. Tier clas-
sification is done on the basis of the population of a city, as given in
McKinsey & Co. (2007).
11. The Competition Act, 2002, No. 12 of 2003, [Link]
sections/ditc_ccpb/docs/ditc_ccpb_ncl_India_en.pdf (accessed 17
August 2011).

References
A. T. Kearney. 2010. ‘Expanding Opportunities for Global Retailers—2010
Global Retail Development Index’, A. T. Kearney, available at [Link]
[Link]/images/global/pdf/2010_Global_Retail_Development_
[Link] (accessed 17 August 2011).
DIPP. 2010. ‘Discussion Paper on Foreign Direct Investment (FDI) in Multi-
Brand Retail Trading’, Department of Industrial Policy and Promotion,
Government of India, July 2010.
Economic and Political Weekly. 2007. ‘Editorial: Whither the Small
Traders?’, Economic and Political Weekly, 42(30), 28 July–3 August 2007:
3071–72.
 FDI in Sensitive Sectors •7 9

Guruswamy, M. and Kamal Sharma et al., 2005. ‘FDI in India’s Retail

Sector: More Bad than Good?’ Economic and Political Weekly, 40(7), 12
February–18 February: 619–23.
Images. 2009. ‘India Retail Report 2009’, Images F&R Research, New
Delhi.
Joseph, M. and N. Soundararajan. 2009. Retail in India, New Delhi:
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Academic Foundation.
McKinsey & Co. 2007. ‘The “Bird of Gold”: The Rise of India’s Consumer
Market’, May, San Francisco: McKinsey Global Institute.
MOSPI. 2010. ‘Press Note: Revised Estimates of Annual National Income,
2009–10 and Quarterly Estimates of National Income, 2009–10’, Central
Statistical Office, Ministry of Statistics and Programme Implementation,
May.
Mukherjee, A. and Nitisha Patel. 2005. FDI in Retail Sector in India, New
Delhi: Academic Foundation.
Sarma, E. A. S. 2005. ‘Need for Caution in Retail FDI’, Economic and
Political Weekly, 40(46), 12 November–18 November: 4795–798.
Singh, S. 2010. ‘Implications of FDI in Food Supermarkets’, Economic and
Political Weekly, 45(34), 21 August–27 August: 17–20.
Technopak. 2010. ‘Overview of India’s Consumer and Retail Sector’,
Presented at 2nd Leadership Forum, Thursday, 18 February 2010, The
Leela Kempinski, Gurgaon (NCR).
USTR. 2010. ‘2010 National Trade Estimate Report on Foreign Trade Barri-
ers’, USTR, available at [Link]
reports/2010/NTE/NTE_COMPLETE_WITH_APPENDnonameack.pdf
(accessed 29 July 2011).
 Downloaded by [University of Toronto] at 13:44 15 January 2017

Appendix A
Table A1: Socio-economic Classification

School upto Some Col- General Professional

School SSC/
Education/Occupation Illiterate 4 yrs/Literate lege but not Graduate/ Graduate/
5–9 yrs. HSC
but no Formal Graduate Post Graduate Post Graduate
Unskilled workers E2 E2 E1 D D D D
Skilled labour E2 E1 D C C B2 B2
Petty trader E2 D D C C B2 B2
Shop owner D D C B2 B1 A2 A2
80•Tanu M. Goyal and Arpita Mukherjee

Entrepreneurs — Employee None D C B2 B1 A2 A2 A1

Entrepreneurs — Employee less than 10 C B2 B2 B1 A2 A2 A1
Entrepreneurs — Employee more than 10 B1 B1 A2 A2 A1 A1 A1
Self-employed professionals D D D B2 B1 A2 A1
Clerical/Salesman D D D C B2 B1 B1
Supervisory level D D C C B2 B1 A2
Junior Officers/Executive C C C B2 B1 A2 A2
Middle/Senior Officers/Executive B1 B1 B1 B1 A2 A1 A1
Source: Received during the survey. Originally developed by Market Research Society of India
 3
FDI and Precision Agriculture in India
Sarah Ahmed
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F
oreign direct investment (FDI) is considered a viable option
for fostering economic growth in host countries. Most of
the developing countries consider FDI as an effective non-
debt creating foreign capital resource with benefits in terms
of technology transfer, skill enhancement, and generation of
employment, income and foreign exchange through increase in
exports. These multidimensional benefits make FDI a very attractive
and important tool for economic development. Considering this
feature, most countries adopt liberal policies to attract FDI.
It is generally theorised that the effect of FDI on domestic
investment would be positive because it is expected that the spillo-
ver benefits of FDI would manifest in the form of increased demand
for inputs, expansion of markets, demand for new products and
markets, encouraging state of the art technology in development
of infrastructure and services. This in turn would increase employ-
ment and income and promote faster economic growth and devel-
opment. But the flip side of this is that it can crowd out domestic
firms due to stiff cut-throat competition, better infrastructure and
production technology, increase in demand for money and the con-
sequent pressure on interest rates. There is also a certain degree
of scepticism that if FDI takes place with redundant technology
then it can have a damaging effect on the environment. However,
with detailed, exhaustive environmental laws in place, their effec-
tive implementation and judicious channelling of FDI flows in the
country, this fear of damage to the environment and crowding out
of domestic firms cannot pose a major threat. Rather, the posi-
tive effects in terms of propelling the economy on the fast track
of development override such probable negative effects. Foreign
direct investment can in fact be the vehicle of positive change in
terms of better technology, innovation, domestic investment, com-
petitiveness, environment sustainability, export competitiveness,
efficiency, better labour skills, and higher employment.
While much research has been done in the context of
the impact of FDI in the industry sector as well as in the services
 82•Sarah Ahmed

sector, there is hardly any study, perhaps none, so far on FDI in the
agriculture sector in the context of the Indian economy. The main
reason could be that FDI was not allowed in this sector until 2006.
However, with the announcement of Press Note 4 of 2006 series
by the Department of Industrial Policy and Promotion, Ministry
of Commerce & Industry, Government of India, FDI up to 100 per
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cent through the automatic route is now allowed in floriculture,

horticulture, development of seeds, animal husbandry, pisciculture,
aquaculture and cultivation of vegetables and mushrooms, under
controlled conditions and services related to agro and allied sectors.
This liberalisation measure in the agriculture sector has generated
interest in researching how FDI will benefit the stakeholders in this
important sector of the Indian economy.
It has also been observed that FDI related to the agricultural
sector is mainly in the agro-processing industry whereby the
benefits of technology and profits from exports are mainly garnered
by the industrial sector. This trend does not contribute to increasing
the income and welfare of a large section of rural population
which is dependent on the agricultural sector. The farmers who
are the producers and suppliers of fruits and vegetables as input
to the rapidly growing, profit making and export-oriented agro-
processing industry are not directly benefitting from the liberal FDI
policy in the agriculture sector.
It goes without saying that India’s concern is not just growth
through FDI and increase in exports but growth with sustainability,
food security and inclusion of the marginalised section of society.
In the context of the agricultural sector, how can we achieve this
objective? Can mere liberalisation of FDI in the agriculture sector
help India achieve this goal? In what way can FDI help foster growth
in agriculture along with reduction in environmental damage? To
achieve this objective, should 100 per cent FDI in agriculture be
linked to investment in precision farming technology? These are the
questions that prompted the writing of this chapter.

Precision Agriculture and its

Importance in the Indian Economy
Precision agriculture (PA) is an information technology–based
farm management system that helps the farmer to identify the
 FDI and Precision Agriculture in India •8 3

variability in soil conditions on his farm and guides him to make

judicious application of seeds, fertiliser, pesticide, and water.
With such information at his disposal, the farmer is able to make
better decisions regarding the use of resources. As such, it has a
wide impact in not only reducing environmental degradation that
occurs due to over-use of agricultural inputs but also in optimising
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food production thus providing food security to the nation and

contributing towards an increase in profits to the farmers through
reduction in the cost of inputs.
The concept of applying information technology for precision
in site-specific management of farms was started in the 1980s in
the US and European countries. This concept came to be known
as precision farming technology which later became better known
as precision agriculture technology. This technology is made up of
various components used at different stages, levels and for different
purposes. Basically, it covers three aspects of the production process:
first is the collection of site-specific data, the second aspect relates to
the analysis or processing of the site-specific or precision data, and
the third concerns providing recommendations or information to the
farmer for the precise application of inputs.
The process consists of various technological components
like remote sensing, geographical information system (GIS),
global positioning system (GPS), soil testing, yield monitors and
variable rate technology. Remote sensing and GIS technology
help in collecting data across the fields and enable the farmer to
process the data for actual site-specific application of inputs. The
GPS helps in data collection like soil sampling, yield monitoring
and during production it assists in locating the level of nutrients,
weeds, etc. Variable rate technology helps in the actual location-
specific application of seeds, fertiliser, herbicides, pesticides, and
actual amount of irrigation required.
India has made rapid advances in the field of information
technology, remote sensing and space technology. Having achieved
this, it would be in context to think of applying this technology
in the field of agriculture, especially when FDI is now allowed in
certain agricultural activities.
According to Patil and Shanwad (2009: 5) precision
farming is important because (a) nutrient variability within a
field can be very high affecting optimum fertiliser rates, (b) yield
potential and grain protein can also vary greatly even within one
 84•Sarah Ahmed

field, affecting fertiliser requirement, (c) increasing fertiliser-use

efficiency will become more important with increasing fertiliser
costs and environment concerns, (d) irrigation at critical stages is
very important, and (e) pest and stress management at early stages
helps the farmer to get maximum yield.
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Formulation of the world trade system and the information

technology (IT) revolution both have changed the external
environment of agricultural development for all countries.
The information and knowledge-based era will create new
opportunities to accelerate the transformation of traditional
farming into modern agriculture. Therefore, it is necessary to
learn the new trends of modern information technology for
agriculture in the developed world and investigate appropriate
ways for promotion of new technology application in developing
countries [Wang Maohua (2001: 46)].

Agricultural cultivation under traditional practices has

proved to be environmentally unsustainable; at the same time
with liberalisation of agricultural trade and removal of quantitative
restrictions under WTO agreements on the one hand and the
requirement of adequate food security at the domestic front on the
other, it is imperative that we improve agricultural production but
with environmental sustainability. Precision agricultural technology
is one such solution. Using information technology enables precise
application of inputs like fertiliser (e.g., fertigation), water and
other factors. This leads to efficient allocation of resources making
agricultural cultivation sustainable with increased productivity.
According to Maohua,

Agricultural high-tech trial farms are emerging very quickly in

many developing countries. The renovation of traditional farming
technology through precision farming techniques is a good strate-
gic objective. It integrates a multidisciplinary approach involving
agronomists in various fields, engineers, manufacturers, and econ-
omists to achieve sustainable development (2001: 47–48)

In this context, wider application of precision agriculture technology,

which is a cutting edge technology in agriculture, becomes impera-
tive for the Indian economy to face global competitiveness in trade
and also maintain food security at home.
 FDI and Precision Agriculture in India •8 5

The Framework: Linking FDI and

Implementation of Precision Agriculture in India
This chapter is based on the premise that liberalising FDI in the
agriculture sector in terms of 100 per cent in horticulture (also
in pisciculture, fisheries, seed development, etc.) through the
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automatic route should be calibrated in terms of investment in

technology and services related to precision agriculture in the
modern management of farms. The objective is that the benefit of
liberal FDI in agriculture should accrue to the farmers too. India
is very well-equipped with remote sensing technology, GIS and
GPS which are some of the components in PA technology. India is
naturally endowed with soil and climatic conditions amenable to
the growth of a wide variety of fruits like guavas, mangoes, litchis,
oranges and grapes, and also vegetables like potatoes, tomatoes,
onions, brinjals, chillis, etc., all of which are used as inputs in agro-
processing industries and also as exports per se. Pilot research on the
use of precision agriculture technology for increasing productivity
and reducing environmental degradation through reduced use
of chemical inputs has shown positive results; this can pave the
way for sustainable agricultural development. One of the limiting
factors in widespread adoption of this technology on Indian farms
is the high cost of components of this technology like VRT, remote
sensors, etc. This gap can be filled if 100 per cent FDI in agriculture
is allowed with the condition that it brings in investment in
precision agriculture technology and consultancy services for the
benefit of the farmers. Consultancy services can be in terms of
collaboration between Indian agricultural scientists and foreign
consultancy service providers to harness the joint advantage of
local knowledge with the experience of foreign experts in the field.
Thus it would be a win-win situation in terms of achieving growth
in the agriculture sector with sustainable development.
The concept of precision farming and its application in
India is still in its nascent stage and efforts are on to test its viability
on Indian farms. Most of the components of the technology for
precision agriculture are available in India. However, the limiting
factors in its widespread adoption are mainly the small size of
farms, prohibitive costs of the technology and lack of literacy on
the part of farmers. Nevertheless, this technology can prove viable
in the case of horticulture and livestock rearing to start with. The
 86•Sarah Ahmed

adoption of this technology would leap-frog the agriculture sector

to a new, higher level and boost the agriculture sector growth
leading to higher GDP growth rate, provided some of the limiting
factors are overcome. In fact, even for cultivation of food crops like
paddy and wheat, the limiting factor of small-sized farms can be
overcome if we consider the farms as a continuous whole, because
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almost all farms in a particular locality have the same cropping

pattern. The second limiting factor of lack of knowledge on the part
of the farmers can be overcome through education and training of
the farmers on-site. The third limiting factor of cost and financing
the adoption of precision agriculture technology can be answered
to a great extent if FDI is attracted in this area.
Horticulture has been recognised as an important alter-
native for diversification in agriculture. India is endowed with
natural soil, topography and weather conditions conducive to grow
a variety of fruits and vegetables across its different agro-climatic
zones. The National Horticulture Mission launched in April 2005
aims to reap in the benefits by ensuring a rigorous approach cov-
ering research, production, post-harvest management, processing,
and marketing. One of the objectives of the Mission is to substan-
tially increase the production to meet the demands of the agro-
processing industries. Implementation of precision agriculture
technology through FDI can help realise this objective of increasing
production through efficient management of resources vis-à-vis the
Green Revolution technology which was essentially a production-
oriented technology but resulted in environmental degradation.

Review of Literature
It must be noted that at this time, while there are several studies
investigating prospects of implementation of precision agriculture
in India (Mondal and Basu, 2009), China and other developing
countries (Maohua, 2001; Zhang et al., 2002), there is no study
on the prospects of FDI in precision agriculture related to India.
Therefore there are no earlier studies or theoretical models to base
this chapter on. Further, the concept of precision agriculture itself
is in its trial stage in India, as such, elaborate data for analysis
too are unavailable to date. These facts pose as limiting factors
for this chapter. As regards analysing the impact of FDI per se on
 FDI and Precision Agriculture in India •8 7

growth and development, as also case studies of sectors other than

agriculture, ample work has been done. There are some studies
on FDI in agricultural land, especially in some countries of Africa
(Hallam, 2009), but as India prohibits FDI in agricultural land, a
review of such a study is not taken up here.
Precision farming should be viewed as a systems approach
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to crop production in which the goal is to reduce decision

uncertainty through better understanding and management of
uncontrolled variation (Dobermann et al., 2004).
According to Patil et al. (2004: 481), precision agriculture

is a micro management system to arrive at improved agricultural

and land management decisions that result from using
information delivered by geospatial technologies. In other words
it is “Digital Agriculture” involving very large scale farm level
mapping, comprehensive database creation on required resources
generated through space based inputs and field observations and
making a detailed plan of work for maximizing the yield and
reducing the cost on inputs using the decision support system.

The National Research Committee (NRC) defines precision

agriculture as ‘a management strategy that uses information
technologies to bring data from multiple sources to bear on
decisions with crop production’. Precision agriculture adjusts
management decisions to suit variations in resource conditions.
Because these conditions vary so widely from farm to farm and
region to region, generalisations about performance across all
situations are unlikely to be true.
Analysis by the United States Department of Agriculture’s
(USDA) Economic Research Service shows

that a 10-percent reduction in nutrient and pesticide applications

for major field crops would reduce costs only $2.14 to $23.97 per
acre, while a 10-percent increase in yields would produce gains
of $11 to $162 per acre’ (Heimlich 1998: 22). Heimlich mentions
that ‘plot studies in Minnesota and Missouri showed reductions
in nitrogen applied and in unrecovered nitrogen in the soil with
variable-rate application, at little or no loss in crop yield. A study
in Nebraska demonstrated reductions in pesticide applications
from early detection, and reductions in herbicides from selective
application to weeds (ibid.).
 88•Sarah Ahmed

Dobermann et al. (2004) maintain that variation in soil

nutrient supply may be most significant within a large field, or
among many small fields within a landscape. Both spatial and
temporal variation must be characterised. Site-specific crop
management (SSCM) then aims at improving the input–output
characteristics of the soil and crop system as they vary in space
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and time. Variable rate technology or VRT is one of the important

components of precision agriculture (Shanwad et al., 2004).
Precision agriculture technology is in use in North
America and also in European countries. In US, for example, this
technology is used to achieve sustainable profits with reduction
in environmental damages, for example, leaching of nitrates
and also for efficiency of other inputs like water for site-specific
management of the farms (Dobermann et al., 2004).
To study whole-farm profitability and risks of precision
agriculture and site-specific crop management systems, Brad
Knight and Bill Malcolm (2007) use the Precision Agriculture
Simulation and Investment Model (PASIM) which is a Microsoft
Excel-based model that uses a yield potential model developed by
French and Schultz (1984) to simulate yields under different PA
systems. The basic components of the model are the French and
Shultz Water Use Efficiency (WUE) measure, yield potentials and
nitrogen budgeting, farmer expectations of rainfall, activity gross
margins and uniform vs zone management. The findings reveal
that investment in GPS guidance technology can be a worthwhile
investment. Investment in variable rate technology for more precise
nitrogen applications did not earn a competitive rate of return in
the case study analysed.
In the Indian context, Pinaki Mondal and Manisha Basu
(2009) advocate the use of ‘soft’ and ‘hard’ technology for PA.
According to them, balanced use of soft and hard PA will be the
deciding factor for its success in India. Land fragmentation is
considered to be the main obstacle for large-scale agricultural
mechanisation in India. But these fragmented lands are cultivated
in a family responsibility system, and all small farmers have been
consciously or unconsciously following ‘soft’ PA technology for
centuries. ‘Soft’ PA depends mainly on visual observation of crops
and soil and management decisions based on experience and
intuition, rather than on statistical and scientific analysis. ‘Hard’
PA utilises all modern technologies such as GPS, RS and VRT.
 FDI and Precision Agriculture in India •8 9

Foreign collaboration for precision agriculture is already

underway. For example, the Working Group of India–US Knowl-
edge Initiative on Agriculture has focussed on development of
PA. Likewise the M. S. Swaminathan Research Foundation, under
collaboration with Arava R&D Centre of Israel, has founded a pre-
cision farming centre in Tamil Nadu. It aims to give maximum
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benefit to farmers by applying PA technologies.

Another step along the path of building a database is the
effort to develop an Agro-climatic Planning and Information Bank
which can give single window access to all agriculture-related
information as well as decision support to users of agricultural and
allied sectors. This project is under the aegis of the Indian Space
Research Organisation and the Planning Commission. India being
a predominantly agricultural country with varied crop patterns
and farms, there can be ample opportunities for the application
and sale of PA technologies, including GIS, GPS and RS. There is
widening scope for funding hardware and software for precision
agriculture as well as for consultancy services in connection
with the application of this technology and its viability on farms.
In Japan, for example, the market is estimated to be about US$
100 billion for GIS and about US$ 50 billion for GPS and Remote
Sensing.
In 2003–4, the central government budget announced the
launching of schemes on Hi-tech Horticulture & Precision Farming
with an initial provision of Rs 500 million for 2003–4. The Precision
Farming Development Centres (PFDCs) will play a leading role in
the development of the validation and dissemination of regionally
differentiated technologies. The PFDCs presently exist in 17
locations in the country which are mostly in the state agricultural
universities (SAUs), ICAR institutes and IIT, Kharagpur. On account
of their experience in conducting applied research on plasticulture
application, they have the expertise in terms of manpower and
equipment. The PFDCs will be equipped further with the necessary
hardware and software needed for generating information
on precision farming techniques in the farmers’ fields. Five of
the PFDCs, Indian Agriculture Research Institute, New Delhi;
University of Agriculture Sciences, Bangalore; Gujarat Agriculture
University, Navsari; Indian Institute of Technology, Kharagpur and
Central Institute of Sub-tropical Horticulture (CISH), Lucknow
would be developed as Centres for Excellence for Precision Farming
 90•Sarah Ahmed

(CEPFs). These institutes will be fully equipped to take up research

and development works on precision farming. The CEPFs would
function as mother centres for providing technical support to other
PFDCs located in the region. The ultimate goal will be to make
available all the needed information to the farmers so that they are
in a position to apply the necessary 22 inputs. Other organisations
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like ICAR institutes and institutes in the private sector will also
be involved in technology development. For this purpose financial
assistance would be provided to the PFDCs on a project basis.
Successful adoption, however, comprises at least three
phases including exploration, analysis and execution. Data on
crop yield, soil variables, weather, and other characteristics are
collected and mapped in the exploratory stage which is actually
the database component. Variability in soil conditions, moisture
content, etc., are important aspects of farming which are captured
for precise application of inputs on farms. Collection of accurate
data on soil properties, crop characteristics, weeds and insect
population, crop yield monitoring is important for the success of
precision farming. Such information is important for increasing the
awareness of long-term benefits among farmers. The approaches
to data collection and mapping must, therefore, reflect local needs
and resources. The GPS can be used to identify the location to
collect data for measuring soil and crop characteristics. These data
are converted into readable forms such as different layers of field
maps, with the help of specific computer software and hardware
and the GIS. Remote sensing techniques are utilised to detect soil-
related variables, pest incidence and water stress. In the analysis
phase, factors limiting the potential yield in various areas within
a field and their inter-relationships are examined using GIS-based
statistical modelling. After determining the significance of each
source of variability to profitability of a particular crop and relative
importance of each controllable factor, management actions can be
prioritised and executed.

A Case Study
The application of precision agriculture is already underway on an
experimental basis. The study done by R. Maheswari et al. (2008)
reveals a very favourable picture for adoption of precision farming
in Dharmapuri district of Tamil Nadu. Their analysis based on
 FDI and Precision Agriculture in India •9 1

primary data collected from precision technology farms and non–

precision technology farms reveal that adoption of precision farming
has led to an 80 per cent increase in yield in tomato and 34 per
cent in brinjal production. Increase in gross margin has been found
to be 165 per cent for tomato and 67 per cent for brinjal farming.
The contribution of technology for higher yields in precision
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farming has been 33.71 per cent and 20.48 per cent, respectively,
in tomato and brinjal production. The total productivity difference
between precision and non-precision farming of tomato was 63.86
per cent. Among various sources responsible for total productivity
variation for tomato, the contribution of technology was higher at
33.71 per cent. In the case of brinjal, the productivity difference
between the precision and non-precision farming was estimated
at 28.14 per cent. Among the various sources responsible for total
productivity variation, the contribution of technology was highest
at 20.48 per cent. Lack of finance and credit facilities have been
identified as major constraints in the non-adoption of precision
farming. Lack of knowledge about precision farming technologies
was another important constraint, because a majority of small
farmers were illiterate and were not able to follow and adopt the
latest technology.
What would be the cost of investment in various
components of precision agriculture technology? According to a
study by Tim Stombaugh et al., the size of the investment required
for precision agriculture would be about $7,000 for a yield monitor
and GPS receiver, plus $3–$7 per acre for grid soil testing, and VR
applicators would cost from $3,000 to $5,000.

Role of FDI in Promoting Precision

Agriculture in India
In the Indian context, the basis for precision farming in terms
of collection of exhaustive data is well underway but the cost of
investing in the technological components for on-farm operations
would be prohibitive for the farmers, even if we go by the
assumption that the horticultural farmers themselves invest jointly
on a cooperative society basis. This indeed is one of the major
reasons why PA is not yet adopted on a large scale even by farmers
growing horticulture crops. Horticulture production provides the
 92•Sarah Ahmed

much needed input for agro-industries and there is a growing

demand for fruits and vegetables for value-added production in
the agro-industries. India makes continuous efforts in facilitating
FDI in various sectors by liberalising policies for investment thus
making India a very attractive destination. As per the A. T. Kearney
(2010) FDI confidence index, India ranks third in the world with
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an index of 1.64. This means it is maintaining its position in

the top five favoured investment destinations. India maintains a
liberal and transparent policy for FDI in various sectors with the
expectation that through FDI a majority of the population both in
the rural and urban areas would benefit either directly or indirectly
through spillovers. According to a study by NCAER (2009: 6), ‘FDI
in relatively labour intensive sectors including food processing,
textiles and readymade garments, leather and leather products
and light machine tools with plants set up in small cities close
to rural and suburban areas would tend to have relatively high
employment generating potential’.
Foreign direct investment inflow in India has been mainly
in the services and the manufacturing sectors. The agriculture
sector per se has not witnessed FDI inflow. The fact that FDI in
agricultural land is not allowed as a matter of policy could be
an explanation for this. However, in the wake of liberal policies
for allowing FDI in most sectors barring a few, India has liber-
alised FDI in agriculture too. According to the announcement in
the Annex to Press Note No. 4 (Series 2006), the Government of
India allows 100 per cent FDI through the automatic route in flo-
riculture, horticulture, development of seeds, animal husbandry,
pisciculture, aqua-culture, cultivation of vegetables, mushrooms,
under controlled conditions and services related to agro and allied
sectors. Under the automatic route, the foreign investor or the
Indian company does not require any approval from the Reserve
Bank or Government of India for the investment. This is an impor-
tant policy development considering the fact that almost 57 per
cent of the population is dependent on agriculture for its livelihood
as per the Census 2001. The agricultural sector contributes about
19 per cent to GDP and therefore holds a firm ground to be the
engine of growth for the economy. Chandan Chakraborty and Peter
Nunnenkamp (2006) have given an exhaustive review of literature
on the issue of FDI–growth linkages. It is maintained that certain
sectors (e.g., manufacturing) have witnessed growth attracting
 FDI and Precision Agriculture in India •9 3

FDI while in some cases (e.g., the services sector, infrastructure

and information technology) it is the volume of FDI inflow that
has led to voluminous growth. Considering the fact that precision
agriculture technology is a farm management technology based on
the application of information technology on farms, the expecta-
tion that FDI in PA will bring about a turning point in the scien-
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tific and technological development of the agriculture sector is not

misplaced. However, the fact that growth implications depend on
various factors, including absorptive capacity and local skills, tech-
nological spillovers and linkages between foreign and local firms,
mere opening up of the sub-sectors in agriculture for FDI is unlikely
to work wonders for the sector. The challenge is to improve the
farm sector so as to attract more FDI and at the same time make
FDI more effective in improving the farm sector.
Table 3.1 shows the trend of FDI inflows in the top 10
sectors attracting highest FDI equity inflows. Foreign direct
investment in agriculture has been allowed only since 2006,
therefore high inflows in this sector would understandably take
some time to be in the high FDI investment category.
The table shows that the maximum FDI has been in the
services sector followed by computer software and hardware, and
telecommunications though there has been a decline in 2009–10 in
the services sector as well as in computer hardware and software,
while there is a steady increase in telecommunications, housing,
construction activities and the power sector.
Foreign direct investment inflows data in other sectors
like agro-processing, agricultural machinery and services and
some other selected industries are given in Table 3.2 for the period
April 2000 to February 2011. It is evident that FDI inflow in the
services sector is almost 21 per cent while in agricultural services
and agricultural machinery it is respectively just 1.08 and 0.12
per cent to total FDI inflows worked out in terms of US$. These
data relate to the amount of inflows received through the FIPB/
Secretariat for Industrial Assistance (SIA) route, RBI’s automatic
route and acquisition of existing shares only. Prima facie we can
say that if a higher volume of FDI inflows is attracted in the sector
of agriculture-related machinery and precision equipments, it can
promulgate modernisation and efficiency in the agricultural sector.
This is essential not only for efficient crop production but also for
sustaining the economy as a whole.
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Table 3.1: Sectors Attracting Highest FDI Equity Inflows Amount, in Rs. Crores (US $ in Millions)

Cumulative Inflows % of Total Inflows

Ranks Sector 2006–07 2007–08 2008–09 2009–10
(April ’00-Jan ’10) (In terms of Rupees)
1. Services Sector 21.047 26,589 28,411 18,588 103,041 22%
Financial & Non-Financial (4,664) (6,615) (6,116) (3,877) (23,125)
2. Computer Software & 11,786 5,623 7,329 3,240 42,728 9%
94•Sarah Ahmed

Hardware (2,614) (1,410) (1,677) (678) (9,630)

3. Telecommunications (radio 2,155 5,103 11,727 11,914 40,282 8%
paging, cellular mobile, (478) (1,261) (2,558) (2,461) (8,838)
basic telephone services)
4. Housing & Real Estate 2,121 8,749 12,621 12,693 36,476 8%
(467) (2,179) (2,801) (2,649) (8,161)
5. Construction Activities (in- 4,424 6,989 8,792 10,994 33,171 7%
cluding roads & highways) (985) (1,743) (2,028) (2,316) (7,507)
6. Power 713 3,875 4,382 6,375 20,386 4%
(157) (967) (985) (1,320) (4,510)
7. Automobile Industry 1,254 2,697 5,212 4,817 19,884 4%
(276) (675) (1,152) (1,003) (4,391)
8. Metallurgical Industries 7,866 4,686 4,157 1,676 13,182 3%
(173) (1,177) (961) (350) (3,073)
9. Petroleum & Natural Gas 401 5,729 1,931 1,102 11,278 2%
(89) (1,427) (412) (222) (2,616)
10. Chemicals 930 920 3,427 1,365 10,932 2%
(other than fertilizers) (205) (229) (749) (288) (2,422)
Source: Fact Sheet on Foreign Direct Investment (FDI) from August 1991 to January 2010, Table F. Available at [Link]
[Link] (accessed 20 February 2011).
Note: Cumulative Sector-wise FDI inflows (from April 2000 to January 2010) - Annex-‘B’.
 FDI and Precision Agriculture in India •9 5

Table 3.2: Statement on Sector-wise FDI Inflows from

April 2000 to February 2011
Amount of FDI Inflows % With
Sr.
Sector In Rs. In US $ Total FDI
No.
Crores Millions Inflows*
1. Services Sector 120,164.81 26,872.62 20.89
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2. Computer Software and 47,619.47 10,705.28 8.32

Hardware
3. Telecommunications 47,107.99 10,341.81 8.04
4. Metallurgical Industries 18,222.76 4,174.15 3.24
5. Electrical Equipments 10,678.23 2,360.57 1.83
6. Drugs and Pharmaceuticals 8,393.31 1,882.30 1.46
7. Agricultural Services 6,662.08 1,390.71 1.08
8. Industrial Machinery 5,643.55 1,249.15 0.97
9. Food Processing Industries 5,528.38 1,209.96 0.94
10. Agricultural Machinery 675.83 150.74 0.12
Source: Adapted from Fact Sheet on Foreign Direct Investment (FDI) from August 1991 to
February 2011 Annex –B. Available at [Link]
pdf (accessed 13 August 2011).

*: Percentage of inflows worked out in terms of US $ and the above amount of inflows received
through FIPB/SIA, RBI’s automatic route and acquisition of existing shares only.

Under the 2006 series Press Note 4, 100 per cent FDI is
allowed for horticulture, however, it is the agro-industries which
attract higher FDI as compared to FDI in agricultural machinery;
there is a high presence of MNCs in the agro-industry sector. No
doubt, investment in the agro-industry sector does boost GDP
growth rate, but it does not benefit the farmers directly in terms
of increasing their profits relatively. If FDI in on-farm precision
agriculture technology components is encouraged then there is
a likelihood of farmers benefitting from the new technology and
reaping in higher profits through low input costs. Several studies
have shown that one of the limiting factors of slow and/or non-
adoption of precision agricultural technology on Indian farms is
the high cost of the equipments which the farmers cannot afford.

Suggestions
Investments in agro-industry by the MNCs should be linked to
investment in precision agriculture technology like field monitors,
 96•Sarah Ahmed

VRT, GPS-enabled tractors on those farms from where the raw

inputs of fruits/vegetables are sourced. The logic behind this is
that such a policy would not only increase the growth of agro-
industry and output for value-added exports but also at the same
time include the farmers in the process of growth by increasing
the farm productivity, income and employment in addition
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to reducing environmental damage that occurs on account of

blanket application of fertilisers, water and pesticides. The use
of precision application technology can guide the farmers in the
exact location and amount of pesticide application which can
reduce the pesticide residue on fruits and vegetables. Calculated
application of water and fertilisers can reduce degradation of
land and damage to the ecosystem. While efforts are made to
attract FDI in agro-processing industries, very little attention is
given to attracting FDI in expansion of information technology
in agriculture. Such a step would modernise the technique of
production management on fields with positive returns in terms
of efficient management in the use of inputs and mapping
field and yield variability. In other words, improvement in
information technology in agriculture will lay the foundation for
the introduction of precision farming technique on farms. Other
benefits that are likely to accrue on account of digitisation of the
agriculture sector could be improvement in standard of living of
farmers owing to increase in income and profit, saving of time and
hence more time for other fruitful income-accruing occupations,
employment opportunities for farm managers, agronomists,
agricultural scientists, accountants, and service providers. This
would further contribute towards an increase in GDP and growth
of the economy.
However, one aspect that needs care and attention is data
security and ownership. Due to generation of a large database
related to grid soil testing, satellite images, crop yield monitoring,
etc., and involvement of various agencies, sharing of data is inevi-
table for accurate analysis of farm conditions and yet each agency
and/or data collectors may exercise some degree of ownership of
data and try to exercise control over its use. This may lead to issues
of ownership, sharing, privacy, and also to an extent, security. Such
intellectual property rights issues may come up in the farm sector.
Therefore, the government has to fine tune the existing intellectual
property (IPR) laws to reinterpret them for precision agriculture
 FDI and Precision Agriculture in India •9 7

use and also ensure that all stakeholders agree to them and ensure
adequate protection for data ownership, privacy and security.

Conclusion
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Foreign direct investment inflows have been high mainly in the

services and manufacturing sectors. The agriculture sector does not
figure in the top 10 sectors of FDI investments, despite being the
most important sector in terms of employment as well as in terms of
backward and forward linkages for the development of both industry
and services sectors. In the wake of 100 per cent FDI being allowed
in horticulture, floriculture and other allied agriculture sectors,
concentrated efforts should be made to modernise the agriculture
sector through FDI in precision agriculture technology and education
of the farmers in the use of this technology. Investments in agro-
industry by the MNCs should be linked to investment in precision
agriculture technology. The adoption rate of precision agriculture
will increase in the future with the increasing number of graduates
from agricultural universities and farm managers. Young India is
ready to modernise its rural sector and achieve inclusive growth
with environmental sustainability.

References
A. T. Kearney. ‘Investing in a Rebound: The 2010 A. T. Kearney FDI Confi-
dence Index’, available at [Link]
Investing_in_a_Rebound-FDICI_2010.pdf (accessed 20 February 2011).
BIAC. 1999. Foreign Direct Investment & Environment, BIAC Discussion
Paper, Business and Industry advisory Committee to the OECD. OECD
Conference on Foreign Direct Investment & Environment, The Hague,
28–29 January, available at [Link]
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 100 •Sarah Ahmed

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 4
Trade, Foreign Direct Investment and
Economic Growth Linkages in Selected
South Asian Countries
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Md. Saiful Islam and Syed Imran Ali Meerza

T
he export-led growth hypothesis (ELGH) postulates that
export expansion is one of the main determinants of economic
growth. It holds that the overall growth of countries can be
generated not only by increasing the amounts of labour and capital
within the economy, but also by expanding exports. According to
its advocates, exports can perform as an ‘engine of growth’. Policy
makers in many developing countries are puzzled over whether they
should concentrate on formulating policies that are designed to be
export promotion oriented or import substitution oriented. If export
growth could contribute to economic growth, the former polices
are advocated. However, if economic growth causes export growth,
then the latter is advocated. Of course economic theory supports
both views as there could be bi-directional causality between export
growth and economic growth (Bahmani-Oskooee et al., 2005).
Empirical studies investigating the relation between export growth
and economic growth are inconclusive at best. There are some
studies which identify a positive relationship between export growth
and economic growth. Such studies include Kravis (1970), Voivodas
(1973), Tyler (1981), and Feder (1983). This group of studies uses
cross-section data analysis. However, Jung and Marshall (1985),
Chow (1987) and Dodaro (1993) employ the concept of Granger’s
(1969) causality using time series data. But these studies have failed
to provide strong support for the export-led growth hypothesis
although Dritsaki et al. (2004) and Jayachandran and Seilan (2010)
do support it.
Further, the long- and short-run relationships between
them have also been estimated by applying cointegration and error
correction mechanisms respectively. Such studies, for instance, are
Hatemi and Irandoust (2000) for Nordic economies, Graves and
Holman (1995) and Awokuse (2005) for Korea. Similarly, Lee and
 102•Md. Saiful Islam and Syed Imran Ali Meerza

Pan (2000) investigated eight East Asian countries. Onchoke and

In (1994) examined the relationship between export and gross
domestic product (GDP) for select South Pacific Island nations.
Bahmani-Oskooee and Domac (1995) estimated a long-run
relationship between Turkish exports and domestic production.
Mah (2005) found bi-directional causality in China. Hatemi
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(2002) investigated the bi-directional causal relationship in Japan

and Demirhan and Akcay (2005) found that exports caused
economic growth in Morocco and Jordon. Abdulai and Jaquet
(2002) found that the causal relationship flows from exports to
GDP. Ahmad (2001) estimated that causality exists in support of
export-led growth hypothesis. Kovacic and Djukic (1991) found a
unidirectional causal relationship exists between exports to output
in the Yugoslav economy. Jordaan and Eita (2007) analysed the
causality between exports and the GDP of the Namibian economy
and supported the export-led growth hypothesis by finding that
export caused GDP and GDP per capita.
The linkage between foreign direct investment (FDI) and
economic growth has been the subject of considerable research
for many decades. Yet links between FDI and economic growth
which have been subjected to empirical scrutiny remain the
subject of debate. Foreign direct investment usually helps reach
at least three developmental goals (a) saving investment gap by
contributing the much needed capital for domestic investment;
(b) foreign exchange gap by generating foreign currency through
initial investments and subsequent export earnings; and (c) tax-
revenue gap by accumulating tax revenues through additional
socio-economic activities (Smith, 1997). Shan et al. (1997) and
Pradhan (2009) identified a bi-directional relationship between
economic growth and FDI inflows.
The positive relationship between FDI inflows and exports
in relation to economic performance has been broadly accepted;
however, the empirical work on the relationship is relatively
limited. Surveys and empirical results are always uncertain, which
necessitates a formal testing. Most of the existing research stresses
complementarity and substitutability relationships between
exports and FDI. However, many of these studies do not discuss
the issue of causality between inflows of FDI and exports. Samsu
et al. (2008) found a positive relationship between FDI inflows and
exports in Malaysia.
 Trade, Foreign Direct Investment and Economic Growth Linkages •1 0 3

This study makes several contributions to the literature.

The research work focusses on the emerging countries of South
Asia: Bangladesh, India and Pakistan. These countries are at
different stages of growth. As a result, it is possible to identify the
impact of FDI and export on economic growth at different stages
of growth. The main objective of this research work is to test the
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export-led growth hypothesis and FDI-led growth hypothesis

in these countries. This study also finds a causal link between
exports and FDI for the mentioned South Asian countries. The next
section of this chapter presents data and methodology. We then
discuss the empirical results followed by the conclusion and policy
implications.

Data and Methodology

In this study, the Granger causality test is adopted to estimate the
casual relationship between economic growth, FDI and exports of
Bangladesh, India and Pakistan. Here, the functional form is:
GDP  f(FDI, EXP) (1)
where,
GDP  gross domestic product
EXP  exports
FDI  foreign direct investment
Economic growth is measured by the real GDP, FDI is
measured by the FDI inflows, and exports are measured by the real
revenues of exports. The data used for this study were the yearly
data for the period from 1973 to 2008. Our analysis is based on
time series data at the national level on exports, FDI inflows and
GDP. All of the data are extracted from different published sources.
These include the UNCTAD Handbook of Statistics 2009 and studies
by the United States Department of Agriculture (USDA). All data
are in logarithm form in order to include the proliferative effect of
time series and this is denoted by the letter ‘L’ prior to each variable
name. In this study, E-views and Matlab software were used to
analyse the time series data.

Unit Root Test

For any econometric study, the first step is to check the stationarity
of the variables used as regressors in the model to be estimated.
 104•Md. Saiful Islam and Syed Imran Ali Meerza

Stationarity can be checked by finding out if the time series contains

a unit root. The unit root test is used for individual variables of
time series data with the purpose of ensuring the variables are
integrated. In fact, non-stationary series could result in spurious
regression. This study uses the Augmented Dickey Fuller (ADF)
test for unit roots. The ADF test includes the extra lagged terms
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of the dependent variables in order to eliminate autocorrelation

(Sridharan et al., 2009). In this study, the minimum values of the
Akaike Information Criterion (AIC) and Schwartz Criterion (SC)
have provided the number of relative time lags. The ADF test is
expressed in the following regression equation:
k
Xt  d0  d1t  d2Xt1   aiXti  ut (2)
i=1
The ADF regression tests for the existence of unit root of
Xt, namely in the logarithm of all model variables at time t. Here,
Xti shows the first differences with k lags. On the other hand, ut
adjusts the error of autocorrelation. We need to estimate i and the
coefficients d0, d1 and d2. The null and alternative hypothesis for
the existence of unit root in variable Xt is as follows:
H0 : d2  0
HA : d2  0

Cointegration and Johansen Test

After having completed the examination of the stationarity of each
time series, the next step is to figure out the level of cointegra-
tion between the examined variables. For simplicity, this step in-
vestigates whether the stochastic trends in the examined variable,
which is supposed to contain unit roots, have a long-term rela-
tionship. In addition, cointegration means that despite being indi-
vidually non-stationary, a linear combination between two or more
time series can be stationary. For the cointegration test, the most
commonly used methods are the Engle and Granger (1987) and
the Johansen (1988) method. The Johansen and Juselius test is a
method of cointegration testing based on the maximum likelihood
estimation of the vector autoregression (VAR) model to determine
the number of cointegrating vectors in the analysis. In this tech-
nique, two test statistics are involved in identifying the number
(r) of cointegrating vectors, namely the trace test statistics and the
maximum eigenvalue test statistics. The test statistics hypothesise
 Trade, Foreign Direct Investment and Economic Growth Linkages •1 0 5

the null hypothesis that there are at most r cointegrating vectors

against the alternative of r or more cointegrating vectors. Mean-
while, the maximal eigenvalue statistics tests are for r cointegrat-
ing vectors against the alternative of r + 1 cointegrating vectors.
The testing hypothesis is the null of non-cointegration
against the alternative, that is, the existence of cointegration by
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using the maximum likelihood procedure (Johansen and Juselius,

1990). An autoregressive coefficient is used for the modelling of
each variable (which is regarded as endogenous) as a function of
all lagged endogenous variables of the model. The outline of the
Johansen test is given as follows:
If Zt denotes a p  1 vector of variables which are not
integrated in order higher than one, then Zt can be formulated as a
vector autoregression (VAR) model of order k:

Zt  Z
1 t1
 Z
2 t2
  kZtk 
Deterministic components  1t
(3)

where, 1t is independently and normally distributed and 1, 2,

, tk are coefficient matrices.
In order to apply the Johansen test a sufficient number of
time lags are required. It is better to follow the relative procedure
which is based on the calculation of likelihood ratio test statistics
(Sims, 1980).

Granger Causality Test

The next step is testing for Granger causality among the variables.
In applied work, the Granger causality modelling has received
considerable attention. The Granger causality test assumes that the
information relevant to the prediction of the respective variables is
contained solely in the time series data on these variables (Gujarati,
1988). The model is used in order to determine the Granger causal
relationships between mentioned variables in this study. Although
cointegration indicates the presence or absence of Granger
causality, it does not indicate the direction of causality between
the variables. Thus, the causality test helps us to verify whether
change in any series can be explained by the other two series. In
this study, the testing criterion is the F statistic. Hypotheses of
statistic significance of specific groups of explanatory variables
have tested for each separate function with the F statistic.
 106•Md. Saiful Islam and Syed Imran Ali Meerza

Empirical Results
The results of the ADF test (Tables 4.1, 4.2 and 4.3) suggest that
the null hypothesis of a unit root in the time series can not be
rejected at 5 per cent significance on their level in case of all
the countries. The first differencing of series removes the non-
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stationary components for Bangladesh and the null hypothesis of

non-stationarity is clearly rejected at 10 per cent significance level
in case of FDI, and 5 per cent significance level for exports and

Table 4.1: DF/ADF Unit Root Tests for Bangladesh

In their Levels 1st Differences

Variables
Test Statistics (DF/ADF) Test Statistics (DF/ADF)
LEXP 2.41 6.54*
LGDP 0.55 4.41*
LFDI 2.14 3.64***
Source: Authors’ calculation.
Note: *** denotes 1% level of significance, ** 5% level of significance and *10% significance
level respectively.

Table 4.2: DF/ADF Unit Root Tests for India

In their Levels 1st Differences 2nd Differences

Variables Test Statistics Test Statistics Test Statistics
(DF/ADF) (DF/ADF) (DF/ADF)
LEXP 3.96 2.56 5.05***
LGDP 1.32 1.58 9.48***
LFDI 5.73 2.06 12.50***
Source: Authors’ calculation.
Note: *** denotes 1% level of significance, ** 5% level of significance and *10% significance
level respectively.

Table 4.3: DF/ADF Unit Root Tests for Pakistan

In their Levels 1st Differences 2nd Differences

Variables Test Statistics Test Statistics Test Statistics
(DF/ADF) (DF/ADF) (DF/ADF)
LEXP 0.58 4.35 8.20***
LGDP 4.60 2.67 8.13***
LFDI 4.38 2.10 6.90***
Source: Authors’ calculation.
Note: *** denotes 1% level of significance, ** 5% level of significance and *10% significance
level respectively.
 Trade, Foreign Direct Investment and Economic Growth Linkages •1 0 7

GDP. All the relevant variables of our model are stationary on their
second difference for India and Pakistan, that is, all variables are I
(2) but the entire variables of Bangladesh become stationary after
first difference that is all variables are I (1).
The trace test and maximum eigenvalue test to establish
the number of cointegration vectors is reported in Tables 4.4,
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4.5 and 4.6 for Bangladesh, India and Pakistan respectively. The
optimum lag length is determined by using Akaike Information
Criterion and Schwartz Criterion. Johansen’s cointegration test
for this model indicates that rank one cointegration is present in
the variables for both Bangladesh and Pakistan. However, the rank
of two cointegrations is available in the variables for India. The
results of both the trace test and eigenvalue test reject the null
hypothesis at 5 per cent significance level.

Table 4.4: Johansen and Juselious Cointegration Tests Variables

LGDP, LFDI and LEXP for Bangladesh
Eigenvalues Critical Values
Null Alternative Eigenvalue 95%
r=0 r=1 30.16** 21.13
r<=1 r=2 5.37 14.26
r<=2 r=3 1.29 3.84
Trace statistics
r=0 r>=1 36.83** 29.79
r<=1 r>=2 6.67 15.49
r<=2 r=3 1.29 3.84
Source: Authors’ calculation.
Note: r is the co-integration vector and ** denotes 5% level of significance.

Table 4.5: Johansen and Juselious Cointegration Tests Variables

LGDP, LFDI and LEXP for India
Eigenvalues Critical Values
Null Alternative Eigenvalue 95%
r=0 r=1 61.51*** 21.13
r<=1 r=2 23.88*** 14.26
r<=2 r=3 3.56 3.84
Trace statistics
r=0 r>=1 88.95*** 29.79
r<=1 r>=2 27.44*** 15.49
r<=2 r=3 3.56 3.84
Source: Authors’ calculation.
Note: r is the co-integration vector and **denotes 5% level of significance.
 108•Md. Saiful Islam and Syed Imran Ali Meerza

Table 4.6: Johansen and Juselious Cointegration Tests Variables

LGDP, LFDI and LEXP for Pakistan
Eigenvalues Critical Values
Null Alternative Eigenvalue 95%
r=0 r=1 29.53** 21.13
r<=1 r=2 11.12 14.26
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r<=2 r=3 0.16 3.84

Trace statistics
r=0 r>=1 40.82** 29.79
r<=1 r>=2 11.29 15.49
r<=2 r=3 0.16 3.84
Source: Authors’ calculation.
Note: r is the co-integration vector and **denotes 5% level of significance.

Tables 4.7, 4.8 and 4.9 show the pair-wise Granger causality
test for Bangladesh, India and Pakistan. Both for Bangladesh and
Pakistan, there is unidirectional relationship between GDP and FDI
where the direction is from GDP to FDI. In contrast, the direction is
from FDI to GDP in India. Although FDI is an important contributing
factor for economic development of a country, the present study
does not find any evidence for this claim except in the case of
India. This study does not find any causal link between GDP and
export except for Bangladesh. Although there is a unidirectional

Table 4.7: Granger Causality Test for Bangladesh

Null Hypothesis Alternative Hypothesis F Statistic Result

GDP does not Granger GDP Granger cause 4.33 **
GDP Ÿ
cause export export 0.91 Export
Export does not Granger Export Granger cause
cause GDP GDP
FDI does not Granger FDI Granger cause 2.24 Export Ÿ
cause export export 4.92** FDI
Export does not Granger Export Granger cause
cause FDI FDI
FDI does not Granger FDI Granger cause GDP 0.31 GDP Ÿ FDI
cause GDP GDP Granger cause FDI 4.51**
GDP does not Granger
cause FDI
Source: Authors’ calculation.
Note: *** denotes 1% level of significance **denotes 5% level of significance.
 Trade, Foreign Direct Investment and Economic Growth Linkages •1 0 9

Table 4.8: Granger Causality Test for India

Null Hypothesis Alternative Hypothesis F Statistic Result

GDP does not Granger GDP Granger cause 1.33 No Causal
cause export export 1.70 Link
Export does not Granger Export Granger cause
cause GDP GDP
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FDI does not Granger FDI Granger cause 0.95 Export Ÿ

cause export export 45.30*** FDI
Export does not Granger Export Granger cause
cause FDI FDI
FDI does not Granger FDI Granger cause GDP 10.66** FDI Ÿ GDP
cause GDP GDP Granger cause FDI 3.74
GDP does not Granger
cause FDI
Source: Authors’ calculation.
Note: *** denotes 1% level of significance **denotes 5% level of significance.

Table 4.9: Granger Causality Test for Pakistan

Null Hypothesis Alternative Hypothesis F Statistic Result

GDP does not Granger GDP Granger cause 0.71 No Causal
cause export export 0.78 Link
Export does not Granger Export Granger cause
cause GDP GDP
FDI does not Granger FDI Granger cause 1.68 Export Ÿ
cause export export 11.03** FDI
Export does not Granger Export Granger cause
cause FDI FDI
FDI does not Granger FDI Granger cause GDP 2.33 GDP Ÿ FDI
cause GDP GDP Granger cause FDI 10.87**
GDP does not Granger
cause FDI
Source: Authors’ calculation.
Note: *** denotes 1% level of significance **denotes 5% level of significance.

relationship between GDP and export in Bangladesh, the direction

is from export to GDP. To find out the relationship between FDI and
export, this study finds that for Bangladesh, India and Pakistan,
there is a unidirectional relationship and the direction is from
export to FDI for all these countries.
 110•Md. Saiful Islam and Syed Imran Ali Meerza

Conclusion
The comparative analysis for the causality relationship among GDP,
exports and FDI has been done for three countries. The results from
the comparative analysis are not the same for all countries since
each country is at a different level of development and has followed
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different policies to attain the present level of development. This

study found that the export-led growth hypothesis is not valid for all
selected countries. In the case of Bangladesh, it is the GDP growth
that attracts FDI and GDP also leads to exports growth. Therefore, the
major policy implication is to focus on enhancing productivity through
increasing human capital, removing inefficiencies and other policies
oriented towards economic growth. This will lead to GDP growth that
will stimulate export growth and will also attract FDI in Bangladesh.
Both in India and Pakistan, this study did not find any causal
relationship between GDP and exports. It means that there may be
other channels through which these variables may be influencing
each other. The government needs to identify the other variables to
find out the direction of causality and mechanisms to appropriately
formulate the policies. Particularly for India, FDI proceeds GDP.
So the policy focus should be to make the environment conducive
to FDI by reducing the cost of economic activities and improving
infrastructure facilities. In the case of Pakistan, exports attract
FDI in the long run. So, the policy focus should be to reduce
production inefficiencies in the economy besides removing trade,
fiscal and financial bottlenecks and impediments in infrastructure
development that are restricting export growth.

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 5
Estimating Country-specific
Determinants of Foreign Direct Investment
Flows in India:
Evidence from VAR and the Innovation
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Accounting Model

Bikash Ranjan Mishra

I
ncreased globalisation over the last two decades has led to an
unprecedented growth in the flow of Foreign Direct Investment
(FDI). According to the World Investment Prospects Survey,
2010–12 conducted by United Nations Conference on Trade and
Development (UNCTAD), India is the second most important FDI
destination for transnational corporations (TNCs) in the survey
period. India was also ranked as the fourth most attractive FDI
destination in 2010 according to Ernst and Young’s 2010 European
Attractiveness Survey. India attracted FDI equity inflows of US$
2,014 million in December 2010. The cumulative amount of FDI
equity inflows from April 2000 to December 2010 stood at US$
186.79 billion, according to the data released by the Department
of Industrial Policy and Promotion (DIPP).
Given these facts, it should come as no surprise that a large
number of theoretical explanations as to the very existence of FDI
have been advanced over the years, with many studies focussing
on the investigation of the determinants of such investment.
However, despite the abundance of research, there is at present
no universally accepted model of FDI; there is still some confusion
over the key factors capable of explaining a country’s propensity
to attract investment by multinational enterprises (MNEs), and it
is not yet clear how the country-specific characteristics are likely
to influence the determinants of, and motivations for, FDI inflows.
These unresolved issues are of special importance to India that
now more than ever seeks to attract FDI to fuel economic growth.
The strong growth of FDI has led to extensive empirical
research on its determinants, using cross-section, time-series or
panel data. Despite the considerable amount of research that has
 114•Bikash Ranjan Mishra

been undertaken, empirical work on determinants of Indian FDI

is still limited. Do microeconomic factors, macroeconomic factors
or the MNEs’ business strategy matter? Over the past decade, the
Indian economy has undergone a series of structural reforms. Are
such reforms responsible for an attractive destination for FDI?
These queries stimulate the attention of researchers to investigate
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the determinants of inward flow of FDI into India.

Therefore, first section of this chapter discusses the
meaning and measurement of FDI. The benchmark definitions
given by different international institutions and subsequently the
FDI accounting system in India are also highlighted. The second
section foregrounds some relevant theories and empirical evidences
on various determinants of FDI inflows. The third section looks at
the data and data sources as well as the research methodology
emphasising on econometric model specification. Results and their
interpretations are discussed in the fourth section. Last, but not
the least, the conclusion and policy implications are provided in
the last section.

The Meaning and Measurement of FDI

There is no specific definition of FDI. Different international
organisational bodies like the IMF, OECD, UNCTAD and IBRD
attempt to illustrate the nature of FDI with certain measuring
methodologies. Generally speaking FDI refers to capital flows from
abroad that invest in the production capacity of the economy. It
is usually preferred over other forms of external finance because
it is non-debt creating, non-volatile and its returns depend on the
performance of the projects financed by the investors.

IMF–OECD Definition
As per the guidelines of the IMF’s Balance of Payment Manual,
fifth edition (IMF, 1993, hereafter BPM5) and OECD’s bench-mark
definition of FDI (2003), FDI statistics are a part of the balance
of payment (BoP) statistics. The IMF definition of FDI is adopted
by most countries and also by UNCTAD for presenting FDI data.
According to the IMF BPM5, paragraph 359, FDI is the category
of international investment that reflects the objective of a resident
entity in one economy (direct investor or parent enterprise)
 Estimating Country-specific Determinants in India •1 1 5

obtaining a ‘lasting interest’ and control in an enterprise resident

in another economy (direct investment enterprise).
There are actually two important dimensions incorporated
in the notion of ‘lasting interest’:
(a) The existence of a long-term relationship between the
direct investor and the enterprise.
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(b) The significant degree of influence that gives the direct

investor an effective voice in the management of the
enterprise.
However, there is no specific mention of any time frame
in the concept of lasting interest nor does it explicitly reveal the
criterion for the significant degree of influence. The IMF threshold
is 10 per cent ownership of the ordinary shares or voting power or
the equivalent for unincorporated enterprises.

Components of FDI
As per the recommendations of IMF and OECD, the countries
are expected to collect and disseminate FDI statistics as a part of
the balance of payments and international investment position
statistics. Foreign direct investment flows are the sum of three
basic components; equity capital, reinvested earnings and other
direct investment capital associated with inter-company debt
transactions. The IMF also considers elements such as overseas
commercial borrowing (financial leasing, trade credits, grants,
bonds), non-cash acquisition of equity, investment made by foreign
venture capital investors, earnings data of indirectly held FDI
enterprises, control premium, non-competition fee, and so on.

FDI Accounting in India

Foreign direct investment statistics in India are mentioned and pub-
lished by two official sources: Reserve Bank of India (RBI) and Sec-
retariat of Industrial Assistance (SIA) in the Ministry of Commerce
and Industry. In the Indian context, till the end of March 1991, FDI
was defined to include investment in (a) Indian companies which
were subsidiaries of foreign companies; (b) Indian companies in
which 40 per cent or more of the equity capital was held outside in
one country; (c) Indian companies in which 25 per cent or more of
the equity capital was held by a single investor abroad.
 116•Bikash Ranjan Mishra

The IMF has provided certain guidelines to bring about

uniformity in the reporting of international transactions by various
member countries which enable inter-country comparisons.
Reflecting this, with effect from 31 March 1992, India adopted an
objective criterion for identifying direct investment. It is fixed at
10 per cent ownership of ordinary share capital or voting rights.
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A committee was constituted by the DIPP in May 2002 to bring

the reporting system of FDI data in India into alignment with
international best practices. Accordingly, the RBI has recently revised
data on FDI flows from the year 2001 onwards by adopting a new
definition of FDI. The revised definition includes three categories
of capital flows under FDI: equity capital, reinvested earnings and
other direct investment capital. Previously the reported FDI data
used only equity capital in the balance of payment statistics.

FDI Determinants: Theory and Evidence

It is not surprising that there does not exist any single
comprehensive or general theory that can explain the existence
and interaction among MNCs and FDI in an all-inclusive manner.
As a result of this, the FDI literature is diverse and spans several
different disciplines including international economics, economic
geography, international business, and management. Several
studies provide overviews of FDI theories, for example, Agarwal
(1980), Cantwell and Bellak (1998), Meyer (1998), and Markusen
and Maskus (2002). Most theories of FDI have emerged during
the post-war period, when the forces of globalisation began to
grow. The growing importance of MNCs and FDI during the 1950s
and 1960s gave an impetus to researchers to find theories to
explain the behaviour of MNCs and the existence of international
production.

Theories Assuming Perfect Markets

DIFFERENTIAL RATES OF RETURN
Until the 1960s, FDI was largely assumed to exist as a result of
international differences in rates of return on capital investment.
Capital moves across countries in search of higher rates of return.
However, the implicit assumption of it is that there exists a single
 Estimating Country-specific Determinants in India •1 1 7

rate of return across industries. This implies that bilateral FDI

flows between two countries could not occur, and therefore, the
hypothesis is theoretically unconvincing.

PORTFOLIO DIVERSIFICATION
In making investment decisions, the MNEs consider not only the
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rate of return but also the risk involved. In the light of Markowitz
(1959) and Tobin’s (1958) portfolio diversification theory, the
international diversification of an MNE’s investment portfolio
would reduce the overall risk of the investor.

MARKET SIZE
The market size hypothesis has its roots in neoclassical investment
theory. It focusses on the role of both the absolute size of the
host country’s market and its growth rate. The hypothesis states
that if the market size is larger, then there is greater potential
to lower production costs through the exploitation of scale
economies and thus, the investors’ utilisation of resources will
be more efficient.

Theories Assuming Imperfect Markets

INDUSTRIAL ORGANISATION AND OLIGOPOLISTIC REACTION
The industrial organisation approach (Hymer, 1960) is based on the
idea that due to structural market imperfections, some firms enjoy
advantages vis-à-vis competitors. These advantages (including
brand name, patents, superior technology, organisational know-
how, and managerial skills) allow such firms to obtain rents in
foreign markets that more than compensate for the inevitable
initial disadvantages (for example, inferior market knowledge)
to be experienced when competing with local firms within the
alien environment. Firms, therefore, invest abroad to capitalise on
such advantages. Hymer (1970) also argued that this conduct by
firms, which often results in ‘swallowing up’ competition, affects
market structure. It is the interdependence, rivalry and uncertainty
inherent in the nature of oligopolies that explains the observed
clustering of FDI in such industries. Higher industrial concentration
causes increased oligopolistic reaction in the form of FDI.
 118•Bikash Ranjan Mishra

INTERNALISATION
Buckley and Casson (1976) further extended the market imperfec-
tion approach. In the presence of market failures, it is the internali-
sation of markets across national boundaries that explains the very
existence of international production. It entails the acquisition of
control, through vertical integration, over activities that would
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otherwise be carried out inefficiently through market transactions.

Buckley et al., identified several types of market imperfections,
such as time lags and transaction costs that call for internalisation.
The internalisation approach is at best referred to as a ‘general
theory’ of the MNEs rather than of FDI.

PRODUCT LIFE CYCLE

The product cycle hypothesis (Vernon, 1966) postulates that an
innovation may emerge as a developed country export. Then it
extends its life cycle by being produced in more favourable foreign
locations during its maturing phase. Ultimately, once it reaches
the standardisation phase, it becomes a developing country
export (developed country import). As the product matures and
competition becomes fierce, FDI becomes a more suitable alternative
option. The innovator decides to shift production in developing
countries because lower factor costs make this advantageous.

ECLECTIC APPROACH
Dunning’s framework (1977) states that firms will engage in FDI
if conditions of ownership, location and internalisation (OLI)
advantages are satisfied. Ownership advantages can give a firm
competitive advantage vis-à-vis rivals. These advantages come in
the form of assets such as patents, management or technology and
should have the characteristics of ‘excludability’ and ‘transferability’.
The existence of an internalisation advantage implies that the
firm’s most efficient alternative of using an ownership advantage
is through exports or FDI. If an internalisation advantage is
missing, it is more profitable for the firm to sell the rights of its use
to another firm through licensing. If the possession of ownership
advantages offers internalisation incentives across countries, and if
there are additional location-specific factors like access to natural
endowments, lower factor costs and so on which favour overseas
production over production at home, then the three conditions for
FDI are satisfied.
 Estimating Country-specific Determinants in India •1 1 9

Dunning’s approach which combines elements of different

theories, successfully explains ‘why’, ‘how’ and ‘where’ international
production should be taking place. It can still be regarded as the
most comprehensive FDI framework that has emerged till date.

Box 5.1: ‘OLI’ Advantages and MNC Channels for Serving a Foreign Market
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Mode of Foreign Ownership Internalization Locational

Market Service Advantage Advantage Advantage
FDI Yes Yes Yes

Exports Yes Yes No

Licensing Yes No No
Source: Dunning, J. H. 1981. International Production and the Multinational Enterprise, London:
Allen and Unwin.

FDI and the New Trade Theory

The neoclassical trade theories could not incorporate the concepts
observed in actual flows of international trade such as intra-
industry trade. Therefore, the new trade theories came into
the picture. They construct general equilibrium trade models
including increasing returns to scale, imperfect competition and
product differentiation. The early contributions to the new trade
theories could not incorporate MNCs and FDI but subsequently
new hypotheses emerged. A general equilibrium model with
monopolistic competition was formulated by Helpman (1984
and 1985). He argued that when there is a large difference in
factor endowment between countries and there exist factor price
differences, then firms preferred to locate themselves abroad. The
underlying assumption was that trade costs were set to zero and
MNEs were assumed to choose producing in one location due
to increasing returns to scale. This so-called Factor-Proportions
Hypothesis explained the existence of vertically integrated firms
with geographically fragmented production. Excluding vertical
specialisation, Markusen (1984) used a general equilibrium
model to explain horizontally integrated firms with simultaneous
activities in multiple similar countries.
Horstmann and Markusen (1987) extended the approaches
taken by Helpman and Markusen through the Proximity-Concen-
tration Hypothesis, based on a trade-off between maximising prox-
imity to customers and concentrating production to achieve scale
 120•Bikash Ranjan Mishra

economies. Depending on the costs, when overseas production

was cheaper than trade, firms preferred to invest. In this case FDI
and exports are alternatives and cannot occur simultaneously. The
Proximity-Concentration Hypothesis was further elaborated, by
Horstmann and Markusen (1992) for homogeneous goods and by
Brainard (1997) for differentiated products, with similar results —
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country size positively affected MNEs.

FDI and Knowledge-capital Model

Knowledge-capital or knowledge-based intangible assets share
characteristics giving rise to FDI. It is easy and inexpensive to
transfer knowledge-based assets to new geographical locations
and it can influence the total flow of services of several production
facilities without affecting its productivity. These assets include
patents, human capital, trademarks, and brand name, etc. Markusen
and Maskus (2002) used a general equilibrium framework to
determine the importance of horizontal, vertical and knowledge-
capital models of MNCs.

Export-platform FDI
Ekholm and Hakkala (2007) emphasise an additional form of FDI,
namely export-platform FDI. In this case, an MNC of the home
economy enters into a host economy, produces the goods and
services but these are sold in a third market and not in the parent
or host country market. They explain it in a three-country model
wherein cost of production is high in two countries and low in
one country. Export-platform FDI occurs when a firm in a high-
cost country constructs a plant in the low-cost country in order to
supply the other high-cost country. Many empirical observations
also support this form of FDI.

Other Country-specific Determinants

EXCHANGE RATE
Aliber (1970) suggested that weak-currency countries are likely to
attract FDI due to the higher purchasing power and more efficient
hedging capacity of investors operating from strong-currency
countries. The roots of such argument are laid down in the currency
areas hypothesis. According to this theory, countries with strong
 Estimating Country-specific Determinants in India •1 2 1

currencies tend to be sources of FDI, while countries with weak

currencies tend to be hosts or recipients of FDI. Froot and Stein
(1991: 1194) argue that: ‘to the extent that foreigners hold more
of their wealth in non-dollar denominated form, a depreciation of
the dollar increases the relative wealth position of foreigners, and
hence lowers their relative cost of capital’, so that, ceteris paribus,
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more foreign investors win auctions. In the empirical testing, Froot

and Stein (1991) found that FDI was ‘the only type of capital inflow
that is statistically negatively correlated to the value of the dollar’.
Moreover, a number of other studies, like Klein and Rosengren
(1994), Gopinath et al. (1998) have provided evidence confirming
the significance of the exchange rate as a key determinant of FDI.

EXPORT ORIENTATION, OPENNESS TO

TRADE AND TARIFF-JUMPING
Multinational enterprises are attracted to export-oriented countries,
because ‘open’ economies tend to instil greater confidence in
foreign investors by virtue of their better performance record and
generally more stable economic climate. The empirical literature
(Culem, 1988; Chakrabarti, 2001) points out that FDI is the result
of MNEs’ attempt to circumvent trade barriers.

SOCIO-POLITICAL INSTABILITY
Unstable social and political environment may deter inward
investment. However, its empirical significance is somewhat
unclear. The reason behind such ambiguity rests in the operational
difficulties inherent in measuring social unrest and political risk
which are complex qualitative phenomena. The available proxies
can only indicate the presence or absence of certain political or
social events rather than their potential manifestation as constraints
upon foreign investors’ operations.

GOVERNMENT INCENTIVES
The role of governments may be restrictive or promotional in
relation to FDI flows. On the one hand it may restrict inward
investment through the establishment of various protectionist
barriers like slow processing of authorisations for FDI. On the other
hand, it may promote various incentives, such as fiscal benefits, tax
concessions and financial benefits like grants and subsidised loans
in order to attract investment by MNEs.
 122•Bikash Ranjan Mishra

Determinants of FDI: Some Empirical Evidences

An extensive set of determinants has been analysed in the literature
on the determinants of FDI. Numerous empirical studies (Agarwal,
1980; Gastanaga et al., 1998; Chakrabarti, 2001; and Moosa, 2002)
lead to a set of explanatory variables that are widely used and
found to be significant determinants of FDI. Markusen and Maskus
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(1999), Love and Lage-Hidalgo (2000), Lipsey (2000) and Moosa

(2002) highlight how the domestic market size and differences
in factor costs can relate to the location of FDI. Gastanaga et al.
(1998), Asiedu (2002) and Froot and Stein (1991) have also
studied the impacts of some specific policy variables like trade
openness, tariffs, taxes, exchange rate and its movements on FDI
flows, and found mixed results.

Data and Methodology

The objective of this study is to examine the country-specific
determinants of FDI in India. The study employs quarterly data
on FDI flows, gross domestic product (GDP), domestic investment
for which gross domestic capital formation (GDCF) is taken as
proxy, exports of goods and services (EXP), real exchange rate
(REER), degree of trade openness (TO) defined as the ratio of
sum of exports and imports of goods and services to GDP, and
interest rate (INTRATE) prevailing in the country defined as the
three months average figure of call money rate. The quarterly data
are only available from the first quarter of 1996 for GDP and the
like variables from the Database on Indian Economy, RBI’s data
warehouse. The sample period in the study is 1996 Q1 to 2009 Q2,
which is largely dictated by the availability of data. The chapter
uses the FDI inflows into the reporting country compiled from the
overall balance of payment quarterly. Gross domestic product at
factor cost is used for GDP and GDCF for domestic investment;
both at constant prices (base period 1999). All the variables are
in terms of Indian currency (Rupees in lakh) except for REER (for
which the chapter calculates average number for three months’
data on trade-based real effective exchange rate) and INTRATE.
Sample size is determined by the data availability which, in turn,
dictates the number of variables to include in the study.
 Estimating Country-specific Determinants in India •1 2 3

Model Specification
Based on the literature review, there is no unanimous conclusion
as to which variable has the most significant and positive impact
on FDI flows. As our specific objective is to determine the most
important country-specific factors that attract foreign direct
investment into India, the following model is employed:
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FDI = f (GDP, GDCF, EXP, REER, TO, INTRATE)

where FDI is foreign direct investment inflow by the reporting

economy, GDP is gross domestic product, gross domestic capital
formation (GDCF) is taken for domestic investment, exports of
goods and services (EXP), real exchange rate (REER), degree of
trade openness (TO) and interest rate (INTRATE) prevailing in the
economy. The above model, based on the theories and evidences
of FDI determinants (mentioned in the previous section), can be
estimated in the following form:

FDIt = b0 + b1 GDPt + b2 GDCFt + b3 EXPt +

b4 REERt + b5 TOt + b6 INTRATEt (1)

Econometric Methodology
Vector autoregression (VAR) approach is commonly used to
investigate the dynamics of the relationship between running
actors like foreign direct investment and other country-specific
factors with reference to India. This will be helpful in internalising
the problems of endogeneity and integrating the order of
variables. However, the present study also employs the innovation
accounting technique (impulse response function and variance
decomposition) to investigate causal relationship. It proposes
that forecast error variance decomposition allows inferences to be
drawn with reference to the proportion of movements in particular
time periods due to its own shocks and shocks arising from other
variables in the VAR. Hence, one can check the impact of a ‘shock’
in a particular variable traced through the system of equations that
determine the impact on other variables and also variables that
include future values of shocked variables.
 124•Bikash Ranjan Mishra

VECTOR AUTO-REGRESSION
A standard VAR is a useful mechanism to determine the interactions
between different variables because it does not impose a priori
restrictions on the causal relationship between the variables.
Instead, the variables are considered endogenous and only further
analysis can tell the cause–effect relationship that prevails.
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For example, a bi-variate VAR (2) model equation by

equation has the form

yt  b10  b12zt  g11 yt1  g12zt1  eyt

yt  b20  b21 yt  g21 yt1  g22zt1  ezt (2)
A VAR is normally expressed in reduced form rather than
the structural form. Let Yt  (y1t, y2t, ....ynt) denote an (n  1)
vector of time series variables. The basic p-lag vector autoregressive
(VAR (p)) model has the form:
yt  0
 1
yt1  2
yt2  ...  p
ytp  et (3)
where Yt  (y1t, y2t, ....ynt) is an (n  1) vector of n endogenous
variables, 0 is an (nx1) vector of constants, j is an (nxn) matrix of
autoregressive coefficients for j=1,2,…p, where p is the lag length
and et is an (nx1) vector of white noise vector process (serially
uncorrelated or independent) with time invariant covariance
matrix .2
To make this analysis, especially j, more clear, in this
representation a VAR (p) model is described containing one lag,
such as:
Yt  A0  A1Yt1  Et (4)
Yt is a vector of endogenous variables at the same lag
order. For example, a VAR (p) with n endogenous variables in the
companion form is equal to:

 
yt

 
yt1 bt
A0
Yt 0
 . (nxp)x1 
(nxp)x1 . ......
0
ytp1
 Estimating Country-specific Determinants in India •1 2 5

 
...

 
1 2 3 p

Et
e
I 0 0 ... 0 t
At 0
 . . . ... . (nxp)x1 
(nxp)x(nxp) ......
. . . ... .
0
0 0 I ... .
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Here I is a (nxn) identity matrix, 0 is a (nxn) null matrix and A1 is

the matrix of the characteristic polynomial.
The innovations are independent Gaussian; this means that
they have mean zero and variance :, a situation that implies that
the errors are serially uncorrelated but correlated across equations.
E(et)  0

E(et eT)   , t  T
0, otherwise
 (5)

Why VAR?
The researchers face trade-offs in the choice of different models
used for univariate and multiple time series data: autoregressive
integrated moving average (ARIMA) models, simultaneous or
structural equation (SEQ) systems, error correction models
(ECMs), and vector autoregression (VAR). Box 5.2 presents a
summary of each of these methods, which extends the summary
initially presented in Freeman et al. (1989). The table in Box 5.2
shows the main methodological differences in the specification of
time series models.
The critical point is that VAR models are a generalisation
of the other approaches. Each of the other modelling approaches
focusses on some feature of time series data that may be true in
practice. However, from the standpoint of model formation and
theory testing, the more general approach is a VAR model.
However, the other models can and will do a good job in
some cases when the restrictions in those models are true. They will
provide better inferences, summaries of dynamics, representations
of relationships based on the parsimony principle. But the VAR
model should replace them all under the following conditions:
• Unless we know or test the precise structure of the relationships
among the variables in our models, SEQ models will be mis-
specified.
 Downloaded by [University of Toronto] at 13:44 15 January 2017

Box 5.2: Comparison of Time Series Modelling Approaches

ARIMA Error Correction SEQ VAR

Model Building
Specification Single theory Long and short-run trends Single theory with assump- Recognition of multiple
focussed on and dynamics based tions about endogeneity and theories by including
univariate series on results of tests of exogeneity variables as endogenous
cointegration and unit roots
Estimation Maximum Johansen procedure; one or Higher order OLS and OLS and tests for lag length
126•Bikash Ranjan Mishra

Likelihood; OLS two steps procedure maximum likelihood

methods; correction for
heteroscedasticity and
serial correlation; tests
for over-identification and
orthogonality
Methodological Conventions
Hypothesis Testing Analysis of Tests of cointegrating Analysis of individual Analysis of significance of
individual relationships; short-run coefficients; goodness of fit blocks of coefficients; tests
coefficients dynamics for exogeneity
Dynamic Analysis Dynamic Analysis of cointegrating Simulation; deduction of Forecasts and model
multipliers; vector; impulse responses model dynamics projections; decomposition
intervention of forecast error variation,
analysis impulse responses
Source: Brandt, Patrick T. and John T. Williams. 2007. Multiple Time Series Models. Thousand Oaks, CA: Sage Publications.
 Estimating Country-specific Determinants in India •1 2 7

• For policy or counterfactual analysis, unless the models are

correct, we may make incorrect inferences.
• Finally, if one of our goals is to characterise uncertainty and
dynamics, then VAR models will typically be superior because
they are less likely to be overly precise via ad hoc pretesting of
the models under consideration.
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IMPULSE-RESPONSE FUNCTIONS
The impulse-response functions are important tools that portray
the expected path over time of the variables to shocks in the
innovations; these functions indicate which variables respond
stronger to certain external shocks. The present study seeks to
determine the extent to which every endogenous variable reacts to
an innovation of each variable.
The dynamic interrelationships among the variables in a
VAR framework can be analysed through another important rep-
resentation, that is, vector moving average (VMA). For illustrative
purposes:

 z    a   a  z  e 
yt a10 a11 a12 yt1 e1t
(6)
t 20 21
a22 t1 2t

Let μy and μz be the mean values of {yt} and {zt}. If we

iterate backwards, then:

 z    a   a  z  e 
yt a10 a11 a12 yt1 e1t
(6)
t 20 21
a22 t1 2t

 a a i
1 b12
       b   
yt my 1
zt

mz
  11 12
1b12b21 i0 a21 a22 1
yt

21 zt
(7)

Now define the 2  2 matrix i with elements jk(i) such

that:
Ai1
fi  ________
1
 b12
1b12b21 b21 1
(8)

If we let m  [my mz] the moving average representation

and can be written as:

xt  m   fi ti
(9)
i0
 128•Bikash Ranjan Mishra

The moving average representation gives better explanation

for the interaction between {yt} and {zt}. The coefficients of i can
be used to generate the effects of yt and zt shocks on the entire
time-paths of the {yt} and {zt} sequences. Here jk(i) are impact
multipliers. For example, 12(0) is the instantaneous impact of a
one-unit change in ezt on {yt}. In the sameway, 11(1) and 12(1)
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are the one-period responses of unit changes in eyt1 and ezt1 on

{yt} respectively. The four sets of coefficients 11(i), 12(i), 21(i),
and 22(i) are called the impulse-response functions (IRF). Plotting
the IRF, that is, plotting the coefficients of jk(i) against (i) is a
practical way to visually represent the behaviour of the {yt} and
{zt} series in response to the various shocks. Using the lag operator,
the VMA is equal to:
zt  m  (L) t (10)
Matrix  contains the impulse-response functions; a
coefficient in  will describe the response of an endogenous
variable(s) xi at time t + s to a one-unit change in the innovation
僆jt, ceteris paribus. Or:
xi, ts
_____
 s (11)
 jt
Here s refers to the period. Depending on the number of
periods used in the equations, the impulse-response functions will
show the time-path due to shocks in the error terms. If the stability
condition is satisfied, the response of a variable to a shock in the
system will move it away from its equilibrium but eventually will
tend to return to it. The speed of adjustment will depend on the
influence of each shock in the variable.

VARIANCE DECOMPOSITION
Generally VARs become over-parameterised with the inclusion
of many lags on the right-hand side of the equation, which
makes short-run forecasting difficult to achieve. To overcome
this situation and understand the relationship among the varia-
bles it is common to analyse the properties of the forecast error.
The variance decomposition analysis provides useful informa-
tion about the relative importance of each innovation in affect-
ing the variables in the system. This means that it is possible to
 Estimating Country-specific Determinants in India •1 2 9

separate the proportion of the movements in a sequence due to

its own shocks and other variables’ shocks. We can obtain the
variance decomposition using the same VMA representation that
was previously obtained. Suppose the coefficients of A0 and A1
are known, then the forecasting the various values of xt+i condi-
tional on the observed value of xt. If we update one period (i.e.,
xt1  A0  A1  et1) the conditional expectation of xt1 is:
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Etxt1  A0  A1xt
One-step ahead forecast error is xt1  Etxt1  et1. Similarly, the two-
step ahead forecast of xt+2 is:
Etxt2  [I  A1]A0  A12xt
The two-step ahead forecast error (i.e., the difference between the
realisation of xt+2 and the forecast) is et+2 + A1et+1. More generally:

Etxtn  [I  A1  A12  .....A1n1]A0  An1xt (12)

And the associated forecast error is:
etn  A1etn1  A12 etn2 ........ A1n1et1 (13)
It is possible to write these forecast errors in terms of eyt
and ezt shocks. The forecast error variance decomposition tells us
the proportion of the movements in a sequence due to its ‘own’
shocks versus shocks due to other variables. If ezt shocks explain
none of the forecast error variance of {yt} at all forecast horizons,
we can say that the {yt} sequence is exogenous.

Results and Discussion

At the very outset, a series of Unit Root tests are made to check
whether all the components of the VAR are stationary or not.
Basically, the variables that constitute the VAR model have
undergone Augmented Dickey Fuller test and Phillips-Perron test
both at level and first difference (see Table 5.1). Moreover, the
variables are tested at three distinct phases at the intercept, trend
with intercept and none level.
From Table 5.1, it can be observed that at level tests the
variables like EXP and GDCF are not at all stationary at level.
 Downloaded by [University of Toronto] at 13:44 15 January 2017

Table 5.1: Unit Root Test of the Variables

ADF PP
Trend and Trend and
LEVEL Intercept None Intercept None
Intercept Intercept
FDI 2.3367 3.7859** 2.911 0.2043 2.5201 0.5714
EXP 4.9408 2.1459 5.2795 1.9159 1.7711 4.3742
GDP 3.8725* 1.9182 4.3526* 1.3442 0.7035 0.6609
GDCF 0.0249 1.6399 1.2395 0.1628 3.1502 3.0445
130•Bikash Ranjan Mishra

REER 2.8497*** 2.7995 0.3980 2.8231*** 2.7557 0.5075

INTRATE 4.4103* 4.9783* 1.6680*** 4.4820* 5.0392* 1.5282
TO 3.0771 0.4297 4.6335 0.6326 3.4896*** 1.8072
ADF PP
1st Trend and Trend and
Intercept None Intercept None
Difference Intercept Intercept
FDI 6.8472* 7.7385* 1.7012** 10.0984* 15.8111* 8.7243*
EXPORT 0.2382 5.9425* 1.8839 7.2700* 12.9665* 6.3231*
GDP 0.6219 4.3422 1.1303 3.0107** 3.2109*** 3.0525*
GDCF 1.9399 1.9547 1.0796 16.7509* 17.9203* 11.7871*
REER 8.6905* 8.7423* 8.7613* 9.1402* 9.6852* 9.1997*
INTRATE 7.2371 7.1685* 7.2897* 29.4687* 30.0267 23.6700*
TO 1.6738 6.8166* 0.5723 8.4611* 9.5891* 6.8628*
Source: Author’s calculations.
Note: * , ** , *** indicate significant value at 1%, 5% and 10% level of significance respectively.
 Estimating Country-specific Determinants in India •1 3 1

However, FDI is found to be stationary at 5 per cent level of

significance at trend with intercept level in ADF test but not in
other tests. Gross domestic product is stationary in ADF test at
1 per cent level of significance. The REER is stationary at 10 per
cent significance level in the ADF as well as PP test. The INTRATE
is stationary at different significance levels in both tests. The TO
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is only stationary at 10 per cent significance level in the PP test.

Therefore, there exist mixed types of variables some of which
are stationary and others are non-stationary. However, at first
difference all variables are found to be stationary in PP test. In the
ADF test, they are found to be stationary at different significance
levels except the variables GDP and GDCF. If the focus is only on
the PP test, then the variables are found to be stationary.
There is a debate on the characteristics of the variables
included in a VAR model. Sims et al. (1990) recommended against
the differencing of the variables even if they contain unit root.
The argument behind such a recommendation is that the purpose
of a VAR analysis is not to estimate parameters, rather it is to
determine co-movements among the variables. If the differencing
of the variables is undertaken, then it may undesirably throw away
information relating to co-movements in the data. Keeping these
recommendations in mind, the variables are taken as level and no
modification is made.
A reduced form VAR (where the number of lags of all the
variables is the same as in all equations) is employed so that each
equation can be effectively estimated using OLS. However, in order
to determine the appropriate lag lengths, several selection criteria
like Akaike Information Criterion (AIC), Schwarz Information
Criterion (SC), Sequential modified LR test statistic (LR), final
prediction error (FPE), Hannan-Quinn information criterion (HQ)
are employed. The results are reported in Table 5.2. The standard
results about the properties of the VAR coefficients and VAR
estimation (e.g., Hamilton, 1994: Chapter 11) depend on the lag
length of the VAR. As a rule of thumb, for quarterly data, one can
go up to six lags. This captures the cyclical components in the year
and any residual seasonal components in most cases. In the present
case, several criteria are used to detect the lag length and most of
them indicate that it should ideally be two.
 132•Bikash Ranjan Mishra

Table 5.2: VAR Lag Order Selection Criteria

Endogenous Variables: FDI GDP GDCF EXP REER TO INTRATE

Lag LogL LR FPE AIC SC HQ

0 2750.184 NA 2.68e+37 106.0455 106.3082 106.1462
1 2578.239 290.9844 2.41e+35 101.3169 103.418* 102.1225
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2 2501.414 109.3267* 9.13e+34* 100.2467* 104.1867 101.757*

Source: Author’s calculations.
Note: * indicates lag order selected by the criterion
LR: sequential modified LR test statistic (each test at 5% level)
FPE: Final Prediction Error
AIC: Akaike information criterion
SC: Schwarz information criterion
HQ: Hannan-Quinn information criterion

Since a VAR includes many lags of variables, it will be

difficult to observe which sets of variables have significant effects
on each dependent variable and which do not. The Granger
(1969) approach to the question of whether x causes y is to see
how much of the current y can be explained by past values of y
and then to see whether adding lagged values of x can improve
the explanation. The variable y is said to be Granger-caused by x
if x helps in the prediction of y, or equivalently if the coefficients
on the lagged ‘x’s are statistically significant. It is important to
note that the statement ‘x Granger causes y’ does not imply that
y is the effect or the result of x. Granger causality measures
precedence and information content but does not by itself
indicate causality in the more common use of the term. Keeping
this in view, Table 5.3 explains the pair-wise Granger causality
test where the reported F-statistics are actually the Wald statistics
for the joint hypothesis ij=0; for all values of i and j but i z j.
Here, we cannot reject the hypothesis that FDI does not Granger
cause GDP but we do reject the hypothesis that GDP does not
Granger cause FDI. Therefore it appears that Granger causality
runs one-way from GDP to FDI and not the other way. Similar
is the case for GDCF to FDI. However, two-way causality runs
from EXP to FDI and FDI to EXP and from TO to FDI and FDI to
TO. In contrast to this, the causality does not run from either
 Estimating Country-specific Determinants in India •1 3 3

REER or INTRATE to FDI or in the reverse way. That means, the

information content or precedence of GDP, GDCF, EXP, and TO
affect the current figure of FDI. It can be more generalised by
saying that, being ceteris paribus, any current significant change
in the country’s domestic product, domestic investment, export
performance and the degree of openness of the nation towards
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the rest of the world will bring more FDI inflows into India in
the subsequent period.

Table 5.3: Pair-wise Granger Causality Tests

Lags: 2 and Observation: 52

Null Hypothesis F-Statistic Probability

GDP does not Granger Cause FDI 5.11536 0.00977
FDI does not Granger Cause GDP 1.62509 0.20776
GDCF does not Granger Cause FDI 6.50705 0.0032
FDI does not Granger Cause GDCF 0.24856 0.78094
EXP does not Granger Cause FDI 4.16039 0.0217
FDI does not Granger Cause EXP 9.50651 0.00034
REER does not Granger Cause FDI 1.63696 0.20547
FDI does not Granger Cause REER 0.53352 0.59005
TO does not Granger Cause FDI 2.59748 0.08512
FDI does not Granger Cause TO 10.2781 0.0002
NTRATE does not Granger Cause FDI 0.90855 0.41007
FDI does not Granger Cause INTRATE 0.52875 0.59281
Source: Author’s calculations.

However, the term ‘causality’ is merely a misnomer.

The reason behind such a proposition is that it does not prove
the movements of one variable cause the movement of another,
rather it only means a correlation between the current value of
one variable and the past values of others. The F-test results,
mentioned earlier, cannot explain the sign of the relationship or
how long these effects need to come about. Such information will
be given by an examination of the VAR’s impulse-response function
and variance decompositions.
 134•Bikash Ranjan Mishra

Impulse-responses trace out the responsiveness of each

variable over different periods to the shocks that may arise in the
same variable and the remaining others. In other words, if a unit
shock is applied to the error of each variable in each equation
separately, then its effects on the VAR system over time are noted.
The results are shown in the following figures.
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Figure 5.1 gives the impulse-responses of FDI associated

with separate unit shocks to each variable respectively. Since
there are seven variables, a total of 49 impulse-responses could
be generated. But to make it simple, the responses of FDI only
are noted and responses of other variables are not mentioned.
Innovations to FDI always have a positive impact on FDI (see
Figure 5.1). The effect of the shock also slowly dies down. One
unit shock applied to GDP results in an initially positive impact
up to three years. Then it changes and results in negative effect
for the next two periods. But after the sixth period, the impact
becomes positive and remains so for the entire 10 periods. The
impact on FDI is also positive when an innovation takes place
on domestic investment, though its strength gradually declines.
Innovations to export have a mixed impact on FDI. To start with,
it becomes positive but its magnitude is not so high and after two
periods of time, it becomes negative. Again the magnitude is not
very significant. It reaches its mean level after five periods and
then there is no sign of further departure. That means, export
has a small period effect on FDI but in a sufficiently longer time,
the effect dies away. On the other hand, one unit shock applied
to the exchange rate results in an initially negative impact up
to three years. Then it changes sign and results in a positive
effect for the next three periods. But after the sixth period, the
impact becomes nearer to its mean value and remains so for the
entire 10 periods. When an innovation takes place on interest
rate and trade openness, the impact on FDI is negative. The only
difference between interest rate and trade openness is that, in
the case of the former, the negative effect gradually increases
but in the case of the latter, the negative effect gradually decays
down. To conclude, FDI and domestic investment have a positive
impact and interest rate and openness have a negative effect on
FDI. Export and exchange rates have a small period effect on
FDI.
 Estimating Country-specific Determinants in India •1 3 5

Figure 5.1: Response to Cholesky One S.D. Innovations  2 S.E.

Response of FDI to FDI Response of FDI to GDP

8000 8000

6000 6000

4000 4000
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2000 2000

0 0

⫺2000 ⫺2000

⫺4000 ⫺4000
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of FDI to GDCF Response of FDI to EXP01

8000 8000

6000 6000
4000 4000
2000 2000
0 0
⫺2000 ⫺2000

⫺4000 ⫺4000
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of FDI to REER Response of FDI to INTRATE

8000 8000
6000 6000
4000 4000
2000 2000
0 0
⫺2000 ⫺2000

⫺4000 ⫺4000
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of FDI to TO
8000

6000

4000

2000

⫺2000

⫺4000
1 2 3 4 5 6 7 8 9 10

Source: Author’s calculations.

 136•Bikash Ranjan Mishra

The variance decomposition gives the proportion of the

movements in the dependent variables that are due to their own
shocks and that of other variables. If a shock arises in any specific
variable, then it will undoubtedly affect that variable and because
of the dynamic structure of the VAR, it will also be transmitted to
all other variables. Table 5.4 gives variance decomposition for FDI
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for the ordering:

FDI, GDP, GDCF, EXP, REER, INTRATE, TO
Table 5.4 and Figure 5.2 give variance decompositions for
FDI. In our results, it can be easily observed that own series shocks,
that is, FDI explain most of the forecast error variance of the series
in the VAR system. Interest rate and domestic investment shocks
account for around 25 per cent of the variance of FDI. Openness
and GDP shocks also account for the variance of FDI and they
become explicable as the time period increases. The export series
seem to have a contemporaneous rather than a lagged effect on
FDI. Shocks from exchange rate series remain more or less constant
and its impact is curbed.

Table 5.4: Variance Decomposition of FDI

Pe-
FDI GDP GDCF EXP REER INTRATE TO
riod
1 100.0000 0.000000 0.000000 0.000000 0.000000 0.000000 0.000000
2 90.46676 0.664793 1.684642 0.508478 3.045318 0.227802 3.402211
3 83.64523 0.948812 5.375190 0.672663 2.672003 1.761725 4.924377
4 76.74961 1.311753 9.052231 0.632388 2.690951 3.658398 5.904669
5 72.85447 1.277341 10.40370 0.653944 2.707299 5.999747 6.103499
6 70.20695 1.675019 10.72849 0.660288 2.580195 7.653403 6.495663
7 67.86912 2.501873 10.63506 0.626072 2.448232 9.481159 6.438478
8 65.62662 2.647516 10.98419 0.654946 2.398289 11.48015 6.208288
9 63.29762 2.762707 11.34572 0.885536 2.371268 13.36147 5.975680
10 61.01414 3.497256 11.44148 1.080450 2.294018 14.94059 5.732068
Cholesky ordering: FDI GDP GDCF EXP REER INTRATE TO
Source: Author’s calculations.
 Estimating Country-specific Determinants in India •1 3 7

Figure 5.2: Variance Decomposition

Percent FDI v ariance due to FDI Percent FDI variance due to GDP
100 100

80 80

60 60
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40 40

20 20

0 0
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Percent FDI v ariance due to GDCF Percent FDI v ariance due to EXP01
100 100

80 80

60 60

40 40

20 20

0 0
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Percent FDI variance due to REER Percent FDI v ariance due to INTRATE
100 100

80 80

60 60

40 40

20 20

0 0
1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Percent FDI variance due to TO

100

80

60

40

20

0
1 2 3 4 5 6 7 8 9 10

Source: Author’s calculations.

 138•Bikash Ranjan Mishra

Conclusion and Policy Recommendations

This study attempts to investigate the long-term relationship
between foreign direct investment and some country-specific
determinants in the case of India. To find out the direction of cau-
sality, innovation accounting approach and Granger causality tests
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are applied. Results of both suggested that there is bi-directional

causality between foreign direct investment and export and FDI
with trade openness. Among the other macroeconomic factors, FDI
and domestic investment have a positive impact and interest rate
and openness have a negative effect on FDI. Export and exchange
rates have a small period effect on FDI. That means the exposure to
the rest of the world and FDI are substitutes. As a country becomes
more open to the rest of the world, there exists a greater chance for
more export and less FDI inflow into that country. This is possible
because export and FDI are two different and alternative modes
of foreign market operation. If trade openness squeezes, then it
attracts foreign investors to open their subsidiaries in the report-
ing country. The results also illustrate that FDI explains most of its
forecast error variance. That means if there is a hike in the inflow of
FDI in the current period, then credit should go to them who were
responsible for the increment of inflow in the previous periods.
Interest rate and domestic investment also significantly account for
the variance of FDI which explains that the foreign direct invest-
ment will flow into that country which exhibits a higher interest
rate and generate sufficient investment on its own. In general,
however, the country-specific macroeconomic factors seem to be
playing a comprehensively significant role in determining FDI.
This means that a country like India needs a stable mac-
roeconomic policy framework. The signs of improvement among
such indicators do actually portray a green signal to the foreign
investors in relation to reporting a country’s risk profile. A set of
strategic and timely implanted policies should be executed keeping
in view these factors. Further, the reporting country should improve
its overall macroeconomic profile which can build an atmosphere
that soothes FDI most.

Y
 Estimating Country-specific Determinants in India •1 3 9

Notes
1. In the structural form, a variable is not only regressed against lagged
values but also against contemporaneous values of other variables in
the system.
2. j is an (nxn) matrix of autoregressive coefficients. j=1,2…p. j the
subscript indicates the corresponding lag. When the system has only
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one lag, the subscript is usually omitted.

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Lipsey, R. E. 2000. ‘Interpreting Developed Countries’ Foreign Direct
Investment’, NBER Working Paper No. 7810, National Bureau of Economic
Research, Cambridge.
Love, J. H. and F. Lage-Hidalgo. 2000. ‘Analysing the Determinants of U.S.
Direct Investment in Mexico’, Applied Economics, 32(10): 1259–267.
Markowitz, H. M. 1959. Portfolio Selection: Efficient Diversification of
Investments, Wiley: Yale University Press (1970 edn).
Markusen, J. R. 1984. ‘Multinationals, Multi-Plant Economies, and the
Gains from Trade’, Journal of International Economics, 16(3–4): 205–66.
Markusen, J. R. and K. E. Maskus. 2002. ‘Discriminating among Alter-
native Theories of the Multinational Enterprise’, Review of International
Economics, 10(4): 694–707.
Meyer, B. D. 1998. ‘Do the Poor Move to Receive Higher Welfare Benefits?’
JCPR Working Papers 58, North-western University/University of Chicago.
Moosa, I. A. 2002. Foreign Direct Investment: Theory, Evidence and Practice,
London: Palgrave.
OECD Benchmark definition of FDI. 2003, available at [Link]
org/dataoecd/26/50/[Link] (accessed 28 January 2011).
Sims, C., J. Stock and M. W. Watson. 1990. ‘Inference in Linear Time Series
Models with Some Unit Roots’, Econometrica, 58(1): 113–44.
Tobin, J. 1958. ‘Liquidity Preference as Behaviour towards Risk’, Review of
Economic Studies, 25(2): 65–86.
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 6
Causality Between Trade, Foreign Direct
Investment and Economic Growth Under the
Structural Adjustment Programme in India:
An Application of the Toda Yamomoto Test
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Harish

T
he welfare of the nationals of a country depends largely
upon sustainable growth with some level of equity. In this
context, globalisation offers unprecedented opportunities
for developing countries to achieve faster economic growth
through liberalised trade policies and foreign direct investment
(FDI) inflows. During the 1970s, international trade grew more
rapidly than the FDI and there was considerable progress in trade
reforms in most developing countries, generally moving from
an import substitution strategy to an export promotion strategy,
thus making international trade the most important international
economic activity. This situation changed dramatically during the
1980s, when world FDI flows started to increase sharply. During
this period, the world FDI increased in importance by transferring
technologies, establishing markets and procuring networks for
efficient production and sales internationally (Urata, 1998).
Generally speaking, exports, imports and inward FDIs constitute
sources of new ideas, new goods, new domestic competition, and
technology transfer from advanced countries.
The role of trade policy and strategies, and in particular,
outward-versus inward-oriented trade strategies, has been
the focus of considerable academic effort since the adoption of
liberalisation policies in developing countries. Openness has been
considered one of the main determinants of economic growth in
these countries. Most of the empirical research in this area has
focussed on exports as the principal channel through which the
liberalisation process can affect the output level and eventually the
rate of economic growth, which is better known as the export-led
growth hypothesis (ELGH). Nevertheless, the empirical support for
this hypothesis has been mixed. While most cross-section studies
 An Application of the Toda Yamomoto Test •1 4 3

have found a positive association between exports and growth, a

considerable number of studies, applying a range of time-series
methodologies, have found mixed results either supporting or
rejecting the hypothesis.
This fragile nature of results of trade and growth may
have stemmed from the omission of relevant mechanisms through
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which openness can promote growth. Foreign direct investment

and the existence of linkages between trade and FDI can be one
of several mechanisms which translate openness into growth. The
liberalisation process is expected to increase not only trade but
also foreign direct investment, which has been a major channel for
access to advanced technologies by recipient countries and hence
plays a central role in the technological progress (Borensztein et
al., 1998) and growth of those countries. Besides, FDI seems to
promote growth through the generation of productivity spillovers.
Furthermore, FDI may increase the volume of international
trade if there is a complementary relationship between FDI and
trade. A full understanding of the relationship among trade,
FDI and economic growth is therefore important for obtaining a
complete picture of the role played by openness in economic
development.
Relatively low wages and a vast reservoir of trained
manpower make India a natural destination for FDI. However,
till the adoption of the new economic policy in 1991, India had
attracted only a small share of the global FDI, primarily due to
government restrictions on foreign involvements in the country’s
economy. As a follow-up to the initiation of the liberalisation
process in the year 1991, with the adoption of the Structural
Adjustment Programme (SAP), investment regulations were relaxed
and liberalised and new foreign investments were also actively
encouraged, which implied a sharp reversal from the decades of
old policy of discouraging integration of the local economy with the
global economy. India’s recent liberalisation-led foreign investment
de-regulations and policy changes have generated strong interest
amongst foreign investors, turning India into one of the fastest
growing destinations for global foreign direct investment inflows.
Net FDI inflows into India reached an attractive $22.8 billion in
2007, more than five times the $4.0 billion recorded during 2001.
In 2008; it had reportedly jumped to $34.4 billion and in 2009 it
went up to $164 billion. India has truly emerged as the second
 144•Harish

most attractive destination for FDI inflows after China and is

ahead of the US, Russia and Brazil.1 According to the news report
published in October 2009 by the Trade Council of Denmark, India
had achieved a stunning 85.1 per cent increase in FDI inflows in
2008, the highest increase amongst all countries, even as global
flows declined by 14.5 per cent (quoting a recent UNCTAD [2009a]
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study). Similarly, export volume has increased from a mere $16.6

billion in 1990 to $ 163.1 billion in 2008 (an increase of over 1,000
per cent in 18 years!). Policy makers and research scholars have
been touting this impressive growth in exports and FDI in recent
decades as vehicles for India’s accelerated growth in the recent
years and possibly in the decades to come. The positive relation
between openness and economic growth seems overwhelming, at
least in theory. However, empirical studies of causality between
openness (trade and FDI) and economic growth, have at best
yielded mixed results. Their relations are not as obvious and
straightforward, as have been made out in the survey of literature
in the following section.
The observations on the FDI-growth nexus and the exports–
growth nexus necessitate examination of the closely related third
side of the triangular relationship: the FDI-exports nexus. The
neglect of the FDI-exports nexus in terms of academic discussions
may be due to the fact that this relationship affects economic
growth indirectly and a comprehensive survey or study in this area
does not seem to exist.
The major purpose of this chapter is to investigate
empirically the causal relationship between trade, foreign direct
investment and economic growth by using time-series data for
1970–2009 for India. The study is also relevant because the
twin policy targets of FDI and trade liberalisation have been an
integral preoccupation of various governments of India since the
adoption of the IMF Structural Adjustment Programme of 1991.2
The chapter attempts to contribute meaningfully to the existing
literature on trade–growth, FDI–growth and trade–FDI nexuses in
India before and after the adoption of SAP. Very few studies have
considered all the three variables together in a time-series analysis
in India, which is what this study sets out to do. Further, this study
uses the Toda Yamamoto version of the Granger causality test,
which is widely believed and accepted to be a superior technique
for testing causality empirically.
 An Application of the Toda Yamomoto Test •1 4 5

The chapter is organised in seven sections. After the intro-

duction, the first section reviews the theoretical literature on the
ELG hypothesis, discussing the theoretical basis for the inclusion
of FDI in the analysis. The empirical review is done in the second
section and data sources and model specifications are discussed
in the third section. Research methodology is expounded upon in
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the fourth section. Results of the study are discussed in the fifth
section. Conclusions and policy implications are summarised in the
sixth section. Last section talks about limitations and the scope for
further research.

Review of Theoretical Literature

The analysis of economic growth has come a long way since
Solow’s (1956) and Swan’s (1956) famous contributions;
developments have been particularly rapid since the mid-1980s. In
the neoclassical growth model, technological progress and labour
growth are exogenous; FDI inflows merely increase investment
rate, leading to an increase in per capita income growth in the
transition between steady states but not in the configuration of the
long-term growth equilibrium of the economy. In the new growth
theory of the 1980s, endogenous technological progress and FDI
have been considered to have a permanent growth effect in the
host country through technology transfer and spillover via the
diffusion processes.
In an open economy, technology and trade, especially
through exports and imports, promote economic growth (Grossman
and Helpman, 1991: Chapter 9; Frankel and Romer, 1999; Frankel
et al., 1996). Export-led growth postulates that exports consist
of the principal channel through which the liberalisation process
can affect the output level and eventually the rate of economic
growth. The theoretical rationale for this hypothesis emerges
from several arguments. First, the export sector may generate
positive externalities on non-export sectors through more efficient
management styles and improved production techniques (Feder,
1982); second, the export expansion will increase productivity by
offering potential for scale economies (Helpman and Krugman,
1985); and finally, exports are likely to alleviate foreign exchange
constraints and thereby provide greater access to international
markets (Esfahani, 1991). These arguments have recently been
 146•Harish

supplemented by the literature on the ‘endogenous’ growth theory

(Romer, 1986, 1989; Lucas, 1988; Grossman and Helpman, 1991;
and Edwards, 1992). But in empirical studies there is no uniform
support for ELG among cross-section and time-series studies.
The reasons for the lack of uniform support for the ELG
hypothesis are quite varied, but the empirical literature provides
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at least three explanations: first, the potential non-linearity of the

openness-growth relationship (Baldwin and Sbergami, 2000);
second, explanation based on possible biases of the pre-testing for
non-stationary and cointegration properties before the Granger
causality test (Giles and Mirza, 1999; Giles and Williams, 2000);
and finally, the relation may not be from exports to output but the
other way round.3
The liberalisation process in developing countries
including India has increased not only trade but also the FDI flows.
Inward FDI is an important vehicle for augmenting the supply of
funds for domestic investment thus promoting capital formation
in the host country. Foreign direct investment is also associated
with the generation of positive productivity spillovers, new job
opportunities, enhancement of technology transfers, increased
exports and boosts in the overall economic growth in host countries.
However, the impact of FDI on economic growth is an
empirical question, and varies from country to country depend-
ing upon a set of conditions in the host country. First, the benefits
from FDI rely on the technical capability of host country firms.4
Second, the beneficial impact of FDI is enhanced in an environ-
ment characterised by an open trade and investment regime and
macroeconomic stability.
The traditional Heckscher-Ohlin-Samuelson framework
suggests that international trade and FDI are substitutes assuming
labour and capital can move freely between countries and no
transportation costs apply. The implication is that international
trade involves an indirect exchange of production factors between
countries (Liu et al., 2001). Mundell (1957) also holds that
international mobility of factors of production, including FDI, may
be a substitute for international trade if production functions are
identical across countries. However, Kojima (1975) asserts that if
the mobility of factors moves towards a country with a shortage,
then FDI may have a positive impact on trade.
 An Application of the Toda Yamomoto Test •1 4 7

Like the other cause and effect relationships, the fact

whether ‘FDI causes trade’ or ‘trade cause FDI’ is a matter of
debate (Petri and Plummer, 1998). Dunning’s (1988) eclectic par-
adigm theory implies that FDI and trade are substitutes in that a
firm moves from exporting to FDI when both transaction costs and
manufacturing costs conditions dictate that this is rational for the
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firm. Trade and FDI are related positively (complement) between

asymmetric countries and negatively (substitute) between symmet-
ric countries (Markusen and Venables, 1998). They also depend on
whether FDI is market-seeking (substitutes) or efficiency-seeking
(complements) (Gray, 1998), ‘trade-oriented’ or ‘anti-trade-ori-
ented’ (Kojima, 1973, 2000), or at the early product life-cycle stage
(substitute) or at the mature stage (complement) (Vernon, 1966).
The new trade theory identifies two major determinants
of the FDI-trade relationship (Fontagné and Pajot, 2000). First, the
way a firm is organised. A vertically arranged firm will experience
a complementary relationship between its foreign trade and invest-
ment, with each reinforcing the other. A horizontally arranged firm
will produce a given commodity at one location, probably close to
the market if transport costs are relatively high and the minimum
plant size is not too large. Second, economies of scale reduce the
number of plants to achieve greater efficiency, yet at the same time
transportation costs and trade barriers provide an incentive to
increase the number of plants. If a firm has high fixed costs and
each plant has limited fixed costs, the firm is provided an incentive
to locate production close to its markets and FDI will substitute for
trade if transport costs are a significant factor. Many of these argu-
ments are summed up by Pacheco-López (2005).
It is clear that a full understanding of the relationship
among trade in goods, FDI and output is necessary in order to
analyse the extent and sources of international linkages between
openness and economic performance in developing countries. The
study will, perhaps, be a valuable addition of knowledge to the
existing literature on trade–FDI–growth linkages in India.

Review of Recent Empirical Literature

In the literature, the relationship between FDI, trade and economic
growth has been addressed through various channels. The relationship
has been studied both theoretically and empirically thorough five
 148•Harish

main channels: (a) determinants of growth, (b) determinants of

FDI, (c) determinants of trade, (d) role of multinational firms in
host countries, and (e) direction of causality between the two and
more than two variables.
Since this chapter is based on causality (e), the empirical
review will be focussed and limited to this aspect only. The available
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research works on trade, FDI and economic growth can be divided

largely among the following categories:
(i) Studies analysing the relationship between trade, FDI and
economic growth,
(ii) Studies analysing the relationship between FDI and
economic growth,
(iii) Studies analysing the relationship between FDI and trade.
Some of the important and relevant studies covering trade,
FDI and growth have been reviewed in the following paragraphs.
G. Jayachandran and A. Seilan (2010) have investigated
the relationship between trade, FDI and economic growth for India
over the period 1970–2007. Using the cointegration technique
they concluded that economic growth, trade and FDI appear to be
mutually reinforcing under the open-door policy.
Nathalie et al. (2008) have examined the relationship
between FDI and intraregional trade in East Asian countries by
using the gravity model with panel estimation and have inferred
that FDI is indeed important in explaining the performance of
intra-East Asian import and export trade, particularly in the case of
trade in components and parts, followed by trade in capital goods.
Mayang Pramadhani, et al. (2007) have examined the
causal relationships between inward direct investment, growth
and trade in Indonesia for the period 1990–2004. They seek to
establish whether there were strong, weak, positive or negative
associations between the presence of multinational enterprises
and Indonesian exports and imports to determine the causal links
between the variables.
Nandita Dasgupta (2007) in her study on India has
investigated the effects of international trade and investment-
related macroeconomic variables, namely, exports, imports and FDI
inflows and the outflows of FDI from India over 1970 through 2005
using time-series data analysis, unidirectional Granger causality
from export and import to FDI outflows; but no such causality
 An Application of the Toda Yamomoto Test •1 4 9

was found from FDI inflows to the corresponding outflows from

India, thus concluding that outbound FDI will be affected by the
country’s performance on the trade front.
Frank S. T. Hsiao and Mei-Chu W. Hsiao (2006) in their
study on East and Southeast Asia have examined the Granger
causality relations between GDP, exports and FDI. The authors
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estimated the VAR and Vector Error Correction Model (VECM)

of the three variables to find various Granger causal relations
for each of the eight economies they studied. Fixed effects and
random effects approaches were used to estimate the panel data
VAR equations for Granger causality tests. The panel data causality
results reveal that FDI has unidirectional effects on GDP directly
and indirectly through exports, and there also exists bi-directional
causality between exports and GDP for the group.
Zhang (2005) examined the role of FDI on Chinese export
performance. The result indicated that FDI has a superior influence
on export performance in China at the industrial level.
Pacheco-López (2005) has demonstrated the causal
relationship between inward FDI and export performance in
Mexico by using the the Granger causality test. He concludes that
there is a bi-directional causality between inward FDI and export
performance.
Metwally (2004) tests the impact of European Union FDI
on economic growth in the Middle Eastern countries of Egypt,
Jordan and Oman, during the period 1981 to 2000 by using a
simultaneous-equation model. The simultaneous-equations
model results suggest that higher rates of economic growth result
in a greater inflow of foreign capital. Results also suggest that
there is a feedback effect in the relationship between economic
growth and capital inflow in all sample countries. A greater
inflow of foreign capital leads to growth in the exports of good
and services. The expansion in exports leads to growth in gross
national product that, in turn, encourages the attraction of more
foreign capital.
Melina Dritsaki et al. (2004), investigate the relationship
between trade, FDI and economic growth for Greece over the period
1960–2002. The results of the Granger causality test showed that
there is a causal relationship between economic growth, trade and
FDI. The three appear to be mutually reinforcing under the open-
door policy.
 150•Harish

Alici and Ucal (2003) examined the causal links among

inward FDI, exports and economic growth in the Turkish economy
during the period 1987 to 2002 on a quarter basis and concluded
that there was no linkage of FDI-led export growth in Turkey.
Chakraborty and Basu (2002) explore the cointegrating
relationship between the net inflow of FDI, real GDP, unit cost of
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labour, and the proportion of import duties in tax revenue for India
with the method developed by Johansen and Juselius (1990). They
find unidirectional Granger causality from real GDP to net inflow
of FDI.
Liu et al. (2002) have investigated the causal relationship
between inward FDI, trade and economic growth in China at the
aggregate level from 1981 to 1997 on a quarter basis. A two-way
causal relationship between inward FDI and exports is found.
Liu et al. (2001) examine the causal relationship between
inward FDI and foreign trade between China and 19 economies by
using the Granger causality test during the period 1984 to 1998.
The result reveals that the growth of imports in China leads to the
growth of inward FDI in China.
In general, the survey of recent empirical literature shows
that the causal relations among trade FDI and growth vary with
the period studied, the econometric methods used, treatment of
variables (nominal or real), one-way or two-way linkages, and
the presence of other related variables or inclusion of interaction
variables in the estimation equation. The results may be
bi-directional, unidirectional, or no causality relations. Thus, it is
very important that the assumptions, the treatment of variables,
the sample period, estimation models, and methods should be
clearly indicated in the analysis. In any case, the brief survey
presented here also appears to indicate that there may be some
causality relations among exports, FDI and GDP. The present study
will attempt to follow up on this.

Data Sources, Period of Study and Variables

The necessary secondary data for India for the period 1970–
2009 has been sourced from UNCTAD statistics 2010 and World
Development Indicators–CD ROM 2010.
 An Application of the Toda Yamomoto Test •1 5 1

Based on the literature available, economic growth has

been measured by the real GDP (Y), while proxies for trade (open-
ness) and net inflows of foreign direct investment have been
chosen as the real exports of goods and services (EX) and foreign
direct investment (FDI) net inflows. All variables and data have
been expressed in natural log in order to include the proliferate
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effect of time series and have been symbolised with the letter ‘L’
preceding each variable name.

Research Techniques
Traditionally, to test the causal relationship between two variables,
the standard Granger (1969) test has been employed in the relevant
literature. This test states that, if the past values of a variable Y
significantly contribute to forecast the value of another variable
Xt1 then Y is said to Granger cause X and vice versa. The test is
based on the following regressions:
M N
Yt  b0   bkYtk  al Xtl  ut
k1 l1

M N
Xt  g0   gkXtk  dl Ytl  vt (1&2)
k1 l1

where Yt and Xt are the variables to be tested, and ut and vt are

mutually uncorrelated white noise errors, and t denotes the time
period and ‘k’ an ‘l’ are number of lags. The null hypothesis is l 
l  0 for all ‘l’s versus the alternative hypothesis that l  0 and
l  0 for at least some ‘l’s. If the coefficient ‘l’s are statistically
significant but ‘l’s are not, then X causes Y and vice versa. But if
both l and l are significant then causality runs both ways.
In the Granger causality test, the first step is to check for
the stationarity of the original variables and then test cointegration
between them. According to Granger, the test is valid if the variables
are not cointegrated. Further, the results of Granger causality are
very sensitive to the selection of lag length. Recent developments
in the time-series analysis have suggested some improvements in
the standard Granger test, and are discussed in the following sub-
section.
 152•Harish

Toda and Yamamoto Version of Granger Causality

It has been noted that the traditional Granger (1969) causality test
for inferring leads and lags among integrated variables will end up
with spurious regression results, and the F-test is not valid unless the
variables in levels are cointegrated. New developments in econo-
metrics offer the error correction model (due to Engle and Granger
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[1987]) and the vector auto-regression error correction model (due

to Johansen and Jesulius, 1990) as alternatives for testing of non-
causality between economic time series. Unfortunately, these tests
are cumbersome and sensitive to the values of the nuisance param-
eters in finite samples and therefore their results are unreliable (see
Toda and Yamamoto, 1995; Zapata and Rambaldi, 1997).
Toda and Yamamoto (1995) proposed a simple procedure
requiring the estimation of an ‘augmented’ VAR, even when there is
cointegration, which guarantees the asymptotic distribution of the
MWald statistic. Therefore, the Toda-Yamamoto causality procedure
has been labelled as a long-run causality test. All that is required
to be done is to determine the maximal order of integration dmax,
which is expected to occur in the model and construct a VAR in
their levels with a total of (k  dmax) lags. Toda and Yamamoto
point out that, for d1, the lag selection procedure is always valid,
at least asymptotically, since k > 1d. If d2, then the procedure
is valid unless k1. Moreover, according to Toda and Yamamoto,
the MWald statistic is valid regardless whether a series is I (0), I
(1) or I (2), non-cointegrated or cointegrated of an arbitrary order.
In addition, the MWald test has a comparable performance in size
and power to the likelihood ratio (LR) and Wald tests (Zapata and
Rambaldi, 1997).
In order to clarify the principle, consider the simple
example of a bivariate model, with one lag (k1). That is,
xt  A0  A1xt1  et (3)
Or more fully

      x e 
x1t a a(1) a(1) x1,t1 e1t
 10  11 12
(4)
x2t a20 a(1)
21
a(1)
22 2,t1 2t

where

e  0
e1t
E(et) E
2t
 An Application of the Toda Yamomoto Test •1 5 3

and
E( etet)

To test that x2 does not Granger cause x1, the parameter

restriction (1)
12
0 has been used. If now we assume that x1t and
x2t are I (1), a standard t-test is not valid. Following Dolado and
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Lütkepohl (1996), (1) 12

0 has been tested by constructing the
usual Wald test based on least squares estimates in the augmented
model:

      x     
x1t a a(1) a(1) a(2) a(2) x1,t2 e1t
 10  11 12
 11 12
(5)
x2t a20 a(1)
21
a (1)
22 2,t1
a21 a(2)
(2)
22
x2,t2 e2t

The Wald statistic will be asymptotically distributed as a

Chi Square, with degrees of freedom equal to the number of ‘zero
restrictions’, irrespective of whether x1t and x2t are I (0), I (1) or I
(2), non-cointegrated or cointegrated of an arbitrary order.
Following Rambaldi and Doran (1996), we estimated a
VAR (3) employing the seemingly unrelated regression (SURE)
framework.5 Following TY non-causality test in the present study
these variables can be causally linked in a system as follows:

        
Yt Yt1 Yt2 Yt3 eYt
EXt b b EXt1 b EXt2 b EXt3  eEXt (6)
0 1 2 3
FDIt FDIt1 FDIt2 FDIt3 eFDIt

Variables entering the model are: Real GDP (Y), real

exports of goods and services (EX), net inflows of foreign direct
investment.

Unit Root Test

As a first step in time-series econometrics, this study has applied
the unit root test in order to check the order of integration.6
There are many unit root tests available with each having their
own advantage and disadvantage but in the present chapter,
we have applied the following unit root tests: Augmented Dicky
Fuller (ADF), the Philip-Perron (PP) and Perron 97 unit root tests.
Unit root tests are conducted to verify the stationarity properties
(absence of trend and long-run mean reversion) of the time-series
 154•Harish

data so as to avoid spurious regressions. A series is said to be

(weakly or covariance) stationary if the mean and autocovariances
of the series do not depend on time. A series is said to be integrated
of order d, denoted by I(d), if it has to be differenced d times before
it becomes stationary. Consider the equation:
t  t1  t  et (7)
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where t are optional exogenous regressors, which may consist of

a constant, or a constant and trend,  and  are parameters to be
estimated, and et is assumed to be white noise. If ||t1,  is a
non-stationary series and the variance of  increases with time and
approaches infinity if ||<1, then  is a (trend) stationary series.
Thus, the hypothesis of (trend) stationarity can be evaluated by
testing whether the absolute value of  is strictly less than one.
The ADF test using MacKinnon (1991) critical values
constructs a parametric correction for higher-order correlation by
assuming that the y series follows an AR (p) process and adding p
lagged difference terms of the dependent variable y to the right-
hand side of the test regression.
't  t1  t  1't1  2't2 …. 2't2  t (8)

This augmented specification has been used to test the

hypothesis:
H0 :   0, against H1 :  < 0 (9)
If the null hypothesis H0 :   0 could not be rejected, it
implies that   0 and the series  contains a unit root, where  
 −1 and evaluated by using the conventional t-ratio for 
t ˆ ( se(ˆ ) ) (10)

where ˆ is the estimate of  and se(ˆ ) is the coefficient standard

error.
Phillips (1987) and Phillips-Perron (1988) have suggested
an alternative approach for checking the presence of unit roots
in the data. They have formulated a non-parametric test to the
conventional t-test which is robust to a wide variety of serial
correlation and time-dependent hetroscedasticity. The PP unit root
test requires estimation of the following equation (without trend):
t
xt  t  xiT  t (11)
it
 An Application of the Toda Yamomoto Test •1 5 5

However, both these tests cannot capture structural change

in time-series data which is a very natural situation in today’s
economy. Structural changes occur in many time series due to eco-
nomic crises, policy changes, changes in institutional arrangements
and regime shifts. In recent years, the issue of structural change has
become of considerable importance in the analysis of macroeco-
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nomic time series. One of the problems associated with structural

change is the testing of the null hypothesis of structural stability
against the alternative of a one-time structural break. If such struc-
tural changes are present in the data-generating process, but not
allowed for in the specification of an econometric model, results
may be biased towards the erroneous non-rejection of the non-sta-
tionarity hypothesis (Perron 1989, 1997; Leybourne et al., 2003).
Perron and Vogelsang (1992) and Perron (1997) have proposed a
class of test statistics which allows for two different forms of struc-
tural break: the Additive Outlier (AO) model, which allows for the
structural change to take place instantaneously, and the Innova-
tional Outlier (IO) model. This chapter uses the Innovational Outlier
(IO) model where changes are assumed to take place gradually.
The Perron IO model (1997) allows for a gradual change
in the intercept (IO1) and gradual changes in both the intercept
and the slope of the trend function (IO2) such that:
k
IO1: xt    DUt  t  D(Tb)t  xt1   ct'xt1  et (12)
i1 k
IO2: xt    DUt  t  DTt  D(Tb)t  xt1  ct'xt1  Ht (13)
i1

where Tb denotes the time of break (1 < Tb< T) which is unknown,

1 t DU  if t > Tb and zero otherwise, DTt  Tt if t > Tb and zero
elsewhere, D (Tb )  1 if t  Tb 1 and zero otherwise, xt is any
general ARMA process and et is the residual term assumed to be
white noise.
The null hypothesis of a unit root is rejected if the
absolute value of the t-statistic for testing   l is greater than
the corresponding critical value. Perron (1997) suggests that the
time of structural break (Tb) can be determined by two methods.
The first approach is that equations (1) or (2) are sequentially
estimated assuming different Tb with Tb chosen to minimise the
t-ratio for  1. In the second approach, Tb is chosen amongst all
other possible break point values to minimise the t-ratio on the
estimated slope coefficient ().
 156•Harish

The truncation lag parameter (k) is determined using

the data-dependent method proposed by Perron (1997). The
choice of k in this method depends upon whether the t-ratio
on the coefficient associated with the last lag in the estimated
autoregression is significant. The optimum k (or k*) is selected
such that the coefficient on the last lag in an autoregression of order
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k* is significant and that the last coefficient in an autoregression

of order greater than k* is insignificant, up to a maximum order
k (Perron, 1997). The least restrictive model is tried in the first
place, to be followed by others.

Empirical Results
As the first step, the order of integration for all the five variables
has been determined using ADF, PP and the Perron (1997) test and
the results are presented in Table 6.1.

Table 6.1 Unit Root Test on Levels

With a Constant at With a Constant at Perron97

Variables Levels First Difference IO2 Model
ADF PP ADF PP Tb and k T Result

LY 3.113 3.807 5.683* 5.787* 1991:4 3.6649 I(1)

LX 1.721 1.977 5.926* 5.929* 1984:3 4.6551 I(1)
LFD 3.589* 3.601* 9.525* 12.07* 1979:3 6.451* I(0)
Critical 2.966 2.964 2.964 2.966 5.55
Values
at 5%
Source: Author’s calculation.
Note: *indicates significance at 5% level.

The results show that all the chosen variables have a unit
root test at levels and first difference (except Perron [1997]);
all the variables were found stationary at first difference except
foreign direct investment.7 The Perron (1997) test has been done
to capture the structural break in the time series under test. The
results have shown that all chosen series had a break after the
liberalisation of 1991 in India except the series on Y. This may be
interpreted as that exports (openness) and foreign direct invest-
ment had some impact of the liberalisation process started in
 An Application of the Toda Yamomoto Test •1 5 7

the 1980s in India. All the variables chosen for this study except
foreign direct investment are I (1).
Applying the Toda-Yamamoto (TY) procedure outlined in
the previous section, the nature of causal linkages between the
income openness and foreign direct investment has been examined.
Since the appropriate lag length is important to identify the true
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dynamics of the model, the Akaike Information Criterion (AIC) and

Schwarz Bayesian Criterion (SBC) lag selection criteria have been
used to determine the optimal lag structure of the VAR system. In
most cases, the lags suggested by AIC and SBC are the same. Due
to the importance of serially uncorrelated residuals, higher lag has
been chosen whenever AIC and SBC suggest different lags.
The implementation of the Toda-Yamamoto procedure
involves estimating system equation (6) in the level form. Finally,
Table 6.2 presents the causality test results obtained from the Toda-
Yamamoto test based on SUR estimation in equation (6).8

Table 6.2 Toda-Yamamoto Test Based on SUR Estimation

Mwald Statics
Null Hypothesis
Total(1970–2009) Pre Sap Post Sap
LFDI does not 46.1889*[.000] 16.6781*[.000] 9.5969*[.008]
Granger cause LEX
LEX does not Granger 0.65327 [.721] .23566 [.889] 6.5461*[.038]
cause LFDI
LEX does not Granger 35.5536*[.000] 11.4364*[.003] 14.525*[.001]
cause LY
LY does not Granger 42.7025*[.000] 13.7846*[.001] 8.6005*[.014]
cause LEX
LFDI does not 73.0842*[.000] 30.5958*[.000] 19.639*[.000]
Granger cause LY
LY does not Granger 1.9415 [.379] 1.4314 [.489] 4.708 [.095]
cause LFDI
Source: Author’s calculation.
Note: *indicates significance at 5% and above level. p-values of MWALD statistics are given in
parentheses.

The results of the causality test obtained by application of

the Toda-Yamamoto test and as enunciated in Table 6.2, suggest
that FDI causes trade (openness, EX) and it is not the other way
round in India in the pre-SAP and total period considered. These
empirical results have validated the findings of G. Jayachandran
 158•Harish

and A. Seilan (2010), Koi Nyen Wong and Tuck Cheong Tang
(2007), Zhang (2005), but failed to validate the results of Nandita
Dasgupta (2007), Pacheco-López (2005). However, in the post-
liberalisation period, bi-directional causality between FDI and
trade has been shown.
Growth proxied by real GDP (Y) and trade proxied by
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exports (EX) has shown a bi-directional causality between two of

them in all the periods under study and validates Jim Love and
Ramesh Chandra (2004) but contradicts Sudhakar S. Raju and
Jacob Kurien (2005). Many early studies have also confirmed a
statistical relationship between export growth and output growth
(Michaely, 1977; Balassa, 1978; and Feder, 1982). The relationship
between growth (Y) and FDI is found to be unidirectional with
causality from FDI to Y in all the periods under study. The
result validates Ericsson and Irandoust (2001) but contradicts
Chakraborty and Basu (2002).
Having discussed these causality results, it may be
concluded that in India FDI does effect both growth and openness
(trade and FDI); however, there is no reciprocal relationship except
in the post-SAP period. Openness and income do affect each other.

Conclusion and Policy Implications

Given the brevity of the annual sample period, in addition to
the well-known caveats associated with the Granger concept of
causality, the results of this chapter are only suggestive and should
thus be interpreted cautiously.
The liberalisation process in India, started in the early
1980s, has increased not only trade but also FDI flows. This has
been further strengthened after the adoption of the Structural
Adjustment Programme. Due to the increasing importance of
foreign direct investment, focussing only on trade as a proxy for
openness may be misleading. This is the reason why the principal
aim of this chapter has been to analyse both the export-led growth
hypothesis and the FDI-growth nexus.
However, the empirical results suggest that all the chosen
series for variables used had a structural break after the adoption
of liberalisation in the 1980s itself, the exception being growth, as
the series on growth had a structural break after the adoption of
SAP. These results imply a strong possibility of the liberalisation
process having an impact on trade and FDI.
 An Application of the Toda Yamomoto Test •1 5 9

The findings of the study do not support the export-led

growth hypothesis. Rather they suggest FDI-led growth and FDI-led
trade; FDI has served to integrate national markets into the world
economy far more effectively than could have been achieved by
traditional trade flows alone. The conclusion that inward direct
investment in India leads to increased trade and growth concurs
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with the general theories of development.

However, these results highlight the undoubted benefits of
FDI, they also point to an increased dependence on foreign investors
for future development, and the concentration of resources in the
foreign-owned sector. It is thus very important for the government
to build an effective bridge between the domestic industry and
the foreign export-oriented firms in order to make the most of the
multinational presence in the country.

Limitation and Scope for Further Research

Despite the fact that this study may have been the only one to use
a time series for a period of 38 years, an important limitation for
this study may be the number and choice of variables used as proxy
for growth and openness.
The results also define the further scope for research,
which should be to confirm the results obtained for periods before
and after the adoption of the Structural Adjustment Programme in
India (1991) for both the short and long run with the help of the
autoregressive distributed lag model (ARDL).

Notes
1. Constitutes author’s statement based, derived and inferred from data
sourced and inputs from the UNCTAD survey (2009) and World In-
vestment Report (2009).
2 This is well-documented in the literature on liberalisation in India.
See Harish (2009).
3. This is the main conclusion obtained, among others, by Kunst and
Marin (1989); Clerides et al. (1996); Bernard and Jensen (1999a,
1999b); and Rodriguez and Rodrik (2000).
 160•Harish

4. According to Blomström, et al. (2000) there are a greater number of

studies estimating direct productivity spillovers for developing coun-
tries than for developed countries. The former tends to produce more
mixed results than the latter. These authors argue that the reason for
these mixed results is that FDI contributes to economic growth only
when a sufficient absorptive capability of the advanced technologies
is available in the host economy. Borensztein et al. (1998) and Balas-
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ubramanyam, et al. (1999) obtain similar conclusions.

5. Rambaldi and Doran (1996) demonstrated that this testing procedure
employed in Toda can easily be constructed using a seemingly unre-
lated regression (SUR) framework.
6. For a detailed discussion on unit root test please refer to textbooks on
time-series econometrics.
7. A unit root test (ADF and PP) was also conducted with trend and IO1
and AO models of Perron (1997) were also tried but results are not
presented due to paucity of space but are available from the author
on demand.
8. Two lag was chosen by AIC and SBC for the model and maximum
order of integration is one. As such, the model is worked with three
lags.

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 7
Foreign Direct Investment and Efficiency:
A Stochastic Frontier Analysis

Suman Sharma
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F
oreign direct investment (FDI) is considered to play an impor-
tant role in recipient economies, especially in the developing
economies. Foreign firms bring with them technical know-
how, equipment, management, marketing, and other skills. They
may give rise to different types of externalities in the host country,
which in turn generate spillovers. Productivity spillovers from FDI
occur through three channels: (a) when skilled workers who once
worked for the FDI firms move to local firms, it results in local pro-
ductivity growth (Blomström and Persson, 1983; UNCTAD, 1999);
(b) due to demonstration effect the mere presence of foreign prod-
ucts in domestic markets can stimulate domestic firms’ creative
thinking and thus help generate blueprints for new products and
processes. The technologies that FDI firms bring in have already
been tested by consumers in the foreign markets; similar products
and technologies will likely work well for the host country as well;
and (c) due to the competitive effect, Caves (1974) argues that
the entry of a foreign firm into local markets can force more active
rivalry and an improvement in performance than would a domes-
tic firm at the same scale. This is because FDI is thought of as a
vehicle for disseminating the transfer of technology, including a
higher level of technical efficiency.
The Indian drugs and pharmaceutical industry provides
a unique example of a late industrialising country successfully
building domestic capabilities in a highly competitive knowledge-
intensive industry. The industry which did not have any
technological base to start local production during the 1960s, has
made significant technological transformation during 1970–90 to
achieve near self-sufficiency in raw materials to start production
from as basic a stage as possible. It has also achieved a high degree
of self-sufficiency with regard to its requirements of basic raw
materials and intermediates. One important component of policy
intervention that made this transformation possible is related to
foreign investment in the industry (Pradhan, 2004).
 Foreign Direct Investment and Efficiency •1 6 7

According to the Economic Survey (2009–10), the Indian

pharmaceutical industry has grown from a humble Rs 15 billion
turnover in 1980 to approximately Rs 1006.11 billion in 2009–10
(ibid., September 2009). The country now ranks third in terms
of volume of production (10 per cent of global share) and 14th
by value. The Indian pharmaceutical industry’s growth has been
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fuelled by exports which registered a growth of 25 per cent in

2008–9 (Figure 7.1). Exports of pharmaceuticals have consist-
ently outstripped imports. India currently exports drug inter-
mediates, active pharmaceutical ingredients (APIs), finished
dosage formulations, bio-pharmaceuticals and clinical services.
The top five destinations of Indian pharmaceutical products
are the US, Germany, Russia, the UK, and China. The domestic
pharmaceutical sector has also expanded in recent years.

Figure 7.1: Indian Pharmaceutical Market

90000
80000
70000
60000
Rs crre

50000
40000
30000
20000
10000
0
2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 2008–09

Year

Export Imports Total Domestic

market size market

Source: Economic Survey. 2009–10. Government of India.

The Government of India has now started realising that

the foreign investments not only provide financial resources but
also are a source of technical, managerial and organisational
knowledge which are largely not available in the economy. The
knowledge brought in by FDI firms ultimately spilled to the rest
of the economy contributing to the productivity growth in the
domestic sector. Against this background the present study’s
objective is to determine whether FDI led to productivity gains in
 168•Suman Sharma

the Indian drugs and pharmaceutical industry during 2000–2001

to 2007–8.
An important question is whether FDI inflows bring
productivity spillovers for host countries. The results are mixed so
far. Some empirical studies confirm positive productivity spillovers
from FDI, but others find negative or no spillovers. The mixed
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evidence implies that there is no relationship between FDI and

domestic firms’ productivity. Some studies, however, argue that the
mixed findings may be attributed to domestic firms’ characteristics
or host countries’ ability to absorb productivity spillovers. The
differences in findings depend on research design, methodological
approach, types of data used, estimation strategy, and even on the
construction of the spillover variable.
The pharmaceutical industry has been chosen because
it belongs to the group of the most productive sectors in the
Indian manufacturing industries. An overwhelming presence
of multinational companies (MNCs) in this sector provides a
good basis to examine the role of firm-specific characteristics in
determining the productivity spillovers.
The first section of this chapter presents a brief overview
of the literature on productivity spillovers. This is followed in the
second section by a discussion of the model specification, estimation
techniques and data sources. The main results of our estimation
are presented in the third section section and the conclusion is
given in the last section.

Theory and Related Literature

Foreign firms use superior production technology because of which

they are likely to be more productive than the domestic firms.
Domestic firms have more experience in serving domestic markets
and possess more information regarding the type of products,
consumer preferences and distributional networks relative to
foreign firms. With this superior knowledge, foreign firms are often
assumed to have higher performance levels than domestic firms,
and in particular are seen to be more efficient and productive.
 Foreign Direct Investment and Efficiency •1 6 9

To test this fact this study hypothesises that

H1: Foreign-owned firms are more productive than domestic
firms.
In the literature, it is often argued that the most important benefits to
the host country from the foreign presence are a variety of spillovers.
There are several channels through which knowledge and technology
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are spilled over from the foreign-owned to domestically- owned firms

in host economies. In their studies, Kokko (1992), Blomström and
Kokko (1998), Blomström et al. (2000), and Saggi (2002) show that
foreign firms contribute to higher productive efficiency and to a better
use of existing technology and resources. Foreign enterprises may
provide allocative efficiency in the host country by entering industries
where entry barriers for new firms are high (Caves, 1974). The pres-
ence of foreign firms may reduce monopolistic distortions, and raise
productivity by improving resource allocations in the host economy.
If foreign firms indeed possess superior knowledge relative
to domestic firms, there is a possibility that foreign firms may
generate positive productivity spillovers (Blomström and Kokko,
1998). The effect of the presence of foreign firms on productivity
has been studied in literature. One of the earliest empirical studies
of productivity spillovers from FDI to host countries is Caves
(1974). Using two-digit level data for 22 Australian industries
over the period 1962–66, he concludes that the presence of
relatively high subsidiary shares are associated with higher levels
of productivity in competing domestic firms. Globerman (1979),
applying a similar approach to data on the Canadian manufacturing
sector, concludes that differences in labour productivity levels are
associated with spillover efficiency benefits associated with FDI.
There have been several studies focussing on developing countries,
including Blomström and Persson (1983), who examine the
relationship between foreign investment and spillover efficiency
in the Mexican manufacturing industry using four-digit industry
level data for 1970. The empirical evidence from their study
confirms the findings from the developed world, that is, that
there are efficiency spillovers from foreign-owned to domestically
owned plants. Flores et al. (2000) examine the impact of foreign
direct investment on the productivity of domestic firms in Portugal
at the two-digit level. They find a positive relationship between
domestic firms’ productivity and foreign presence only when there
are differences in technology between the foreign and domestic
 170•Suman Sharma

producers; also these spillovers mostly occur within modern

sectors. Recently, Wei and Liu (2006) assessed the productivity
spillovers from R&D, exports and the very presence of foreign direct
investment in China’s manufacturing sector, based on a panel of
more than 10,000 indigenous and foreign-invested firms for 1998–
2001. Their findings indicate that there are positive inter-industry
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productivity spillovers from R&D and exports, and positive intra-

and inter-industry productivity spillovers from foreign presence to
indigenous Chinese firms within regions.
The empirical evidence on the effect of FDI is, however,
mixed. Some studies, such as, Globerman (1979), Blomström and
Wolff (1994), Caves (1996), and Djankov and Hoekman (2000),
find that FDI has a positive or weak positive effect on produc-
tivity levels. On the other hand, there are other studies, such as
Haddad and Harrison (1993), Kokko (1994), Kokko et al. (1996),
and Aitken and Harrison (1999), establishing that foreign firms
have negative effects on the productivity performance of domesti-
cally owned firms. But these studies together establish the fact that
the effect of FDI is industry-, firm- and host economy-specific. Liu
(2008) has used a large panel of Chinese manufacturing firms and
found that an increase in FDI at the four-digit industry level lowers
the short-term productivity level but raises the long-term rate of
growth in productivity of domestic firms. Her findings establish
that spillovers through backward and forward linkages between
industries at the two-digit level have similar effects on the produc-
tivity of domestic firms, and backward linkages seem to be statisti-
cally the most important channel through which spillovers occur.
On the basis of these arguments this study tests the hypothesis:
H2: There is a positive productivity spillover from FDI
Foreign direct investment (FDI) is assumed to play a crucial role in
economic restructuring and enhancing growth in developing coun-
tries. There are three channels through which the positive spillo-
vers that FDI firms may generate in the development process can
occur, that is, competition effect, human capital effect and demon-
stration effect.
Of these three channels of productivity spillovers, the
first channel is the most important indirect advantage that
foreign firms may generate. Entry of FDI firms leads to the com-
petitive structure of an industry. This increased competition forces
 Foreign Direct Investment and Efficiency •1 7 1

domestic firms to improve their productivity by using more effi-

ciently existing resources, shifting to sophisticated and advanced
technology, providing training to workers, and undertaking R&D
expenditure to develop indigenous technologies. Competition
may result in either positive or negative productivity spillovers
for domestic firms. Aitken and Harrison (1999) indicate that if
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the productivity decline (rise in average costs) from this demand

effect is large enough, net productivity may drop even if foreign
firms generate technology spillovers for the domestically owned
firms. However, these results are relevant only when domestic
and foreign firms compete with one another in the same market.
Based on this review, the benefits generated by inward FDI are
likely to outweigh the costs of foreign ownership of local factors
of production in the host country. Against this background, this
study tests the hypothesis:
H3: Higher competition is associated with larger spillovers from
foreign presence in the industry, that is, positive productivity
spillover through competition.
An empirical study by Borensztein et al. (1998) about the impact
of FDI flows from industrial countries to 69 developing countries
over the last two decades suggests that FDI is an important source
of technology transfer, contributing relatively more to growth than
domestic investment, but indicates that the FDI contribution to
economic growth occurs only when there is a sufficient absorptive
capacity of advanced technologies, or a minimum threshold stock
of human capital to make such transfer possible. This threshold
is estimated to range between 0.75 and 1 year of post-primary
schooling. Similarly, Barrios and Strobl (2002) found that only
domestic firms with high levels of absorptive capacity can experience
positive spillovers from FDI. The most commonly used measure
of absorptive capacity is the extent of research and development
(R&D) expenditure. Kathuria (2002) indicates that there are positive
spillovers from the presence of foreign-owned firms on the total
factor productivity growth of Indian firms, but the nature and type
of spillovers vary depending upon the industries to which the firms
belong and also on the R&D capabilities of the firms.
R&D is usually treated as an important device for economic
growth. It has long been seen as an important source of knowledge
generation and productivity improvement. R&D not only directly
 172•Suman Sharma

affects the productivity of the firm that conducts R&D, but may also
produce spillover effects that increase other firms’ productivity. It
increases productivity by providing new products and processes or
upgrading existing products and processes that enhance profits or
reduce costs. Kinoshita (2001) finds similar evidence in a study
on Czech manufacturing firms during 1995–98. By focusing on
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electrical machinery and the radio and TV sectors, she finds that
R&D is a necessary condition for technology spillovers from FDI. In
a more recent study on 12 Organisation for Economic Cooperation
and Development (OECD) countries, Griffith et al. (2004) also
confirm that R&D plays an important role in knowledge transfer,
besides its role as a medium of innovation. To capture a firm-
specific characteristic in determining the productivity spillovers
from FDI, this study also tests the following hypothesis:
H4: Domestic firms with R&D expenditure gain more produc-
tivity spillovers from FDI than those without R&D expenditure.

Model Specification, Estimation Techniques and

Data Sources
A stochastic frontier production function is applied to panel data
to examine whether FDI inflows enhance economic growth via
efficiency gains and an inefficiency function simultaneously.
The stochastic frontier method (SFM) constructs an efficient
frontier by imposing the same technology across all firms in the
sample. Deviations from the frontier are divided into inefficiency
and noise components. The model of Battese and Coelli (1993,
1995) is used in accordance with the original models of Aigner
et al. (1977) and Meeusen and van den Broeck (1977). It has the
general form:

Yit  f(Xit,a)exp( it) (1)

where Yit is the output of firm i (i = 1, 2, …, N) in year t (t = 1, 2,

…, T); Xit is the corresponding matrix of explanatory variables; a is
the vector of parameters to be estimated; and it is the error term
that is composed of two independent elements, Vit and Uit, such that
it
Vit  Uit. The Vits are assumed to be symmetric identically and
independently distributed errors that represent random variations
 Foreign Direct Investment and Efficiency •1 7 3

in output and are assumed to be normally distributed with mean

zero and variance, V2.
Following Battese and Coelli (1995), the Uits are assumed
non-negative random variables that represent the stochastic shortfall
of outputs from the most efficient production. It is assumed that Uit is
defined by truncation of the normal distribution with mean,
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J
mit  d0  djZjit (2)
j1

and variance, s2, where Zjit is value of the j-th explanatory variable
associated with the technical inefficiency effect of firm i in year t;
and d0 and dj are unknown parameters to be estimated.
The parameters of both the stochastic frontier model and
the inefficiency effects model can be consistently estimated by
the maximum-likelihood method. The variance parameters of the
likelihood function are estimated in terms of s2V s2V  s2 and
2 2
g s /sS.
Given the specification in (1) and (2), the technical
efficiency of production for the i-th firm in the t-th year is defined
by
TEit= exp (Uit) (3)
The prediction of the technical efficiencies is based on its conditional
expectation, given the observable value of (VitUit) (Jondrow et al.,
1982; Battese and Coelli, 1988). The technical efficiency index is
equal to 1 if the firm has an inefficiency effect equal to 0 and it is
less than 1 otherwise.
One of the key steps of the SFM is to choose the appropriate
production function for the analysis. In this chapter, we opt to use
the translog function. The translog production function is specified
in (4).
N N N
In Yit  a0   an In Xnit  0.5  ank In Xnit In Xkit  ait  0.5attt2 
n1 n1 k1
N
 ant In Xnitt  Vit  Uit (4)
n1

where Y implies output, X represents variables that explain output

(labour and capital, so N = 2), t is time, i is firm. The stochastic
frontier production functions, defined by equation (4), and the
technical inefficiency models, defined by equation (2), are jointly
 174•Suman Sharma

estimated by the maximum-likelihood method using FRONTIER

4.1 (Coelli, 1996).1
For testing H1 the study uses a spillover variable; a test of
H2 involves an interacting variable of spillover and competition;
and a test of H3 involves an interacting variable of spillover and
R&D. The interacting variables in H2 and H3 are likely to have
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a high correlation with each other. Therefore, each hypothesis is

tested separately.
To test H1, the subscript j in equation 2 represents the
dummy variable of foreign ownership. These hypotheses are tested
by controlling the age of the firm. Zj in equation 4 includes an inter-
acting variable of competition and spillovers when testing H2, while
it represents an interacting variable of R&D and spillovers when
testing H3. The summary of variables is presented in Table 7.1.

Table 7.1: Description of Variables

Variable Description
Output The net value added (NVA) deflated by the wholesale price
index for drugs and pharmaceutical industry (base 1993-
94=100) represent output.
Capital The net fixed asset (NFA) deflated by the wholesale price index
for machinery and machine tools (base 1993-94=100) repre-
sent capital input.
Labour Labour has been obtained by dividing total wage bill of a firm
by the average industry wage rate obtained from the Annual
Survey of Industries (ASI).
Foreign Foreign ownership, which is measured by a dummy variable: 1
if the share of foreign ownership is greater than 0%; and 0 if
Otherwise
Spillover Spillover variable, is measured by the share of foreign firms’
output over total output
Age The age of ith firm in number of years
HHI Hirschman index for a measure of concentration
R&D Expenditure on research and development (R&D) is measured by
dummy variable: 1 if firm spends on research and development
Spillover*HHI An interacting variable of spillover and HHI, which is a measure
of productivity spillovers through concentration
Spillover*R&D An interacting variable of spillover and R&D dummy, which is
a measure whether R&D firms receive more or less spillovers
Source: Author’s compilation.
 Foreign Direct Investment and Efficiency •1 7 5

Data Sources
The empirical analysis has been conducted with the help of a
sample of Indian pharmaceutical firms drawn from the Prowess
Data Base of the Centre for Monitoring Indian Economy (CMIE).
Our initial sample consisted of 657 firms. Most of the firms were
dropped from the initial sample because of the discontinuity of
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data for several years. A total of 511 firms were thus dropped
from the initial sample. The database contains 1,168 observations
spreading over 2000–2001 to 2007–8.

Model Estimation and Analysis of Results

The first step in the Stochastic Frontier Analysis (SFA) is to find
an appropriate functional form that represents the data. Given the
specifications of the translog model in equation (4), various sub-
models of the translog are considered and tested under a number
of null hypotheses.
A null hypothesis of ant = 0 is to confirm whether Hicks-
neutral technological progress is an appropriate specification for
the dataset, while a null hypothesis of at = att = ant = 0 is for
no-technological progress in the production frontier. In addition, a
null hypothesis of att = ant = ank = 0, for all n and k, is to test for
the Cobb-Douglas production frontier and a null hypothesis of g =
d0 = dj = 0 is to confirm the no-inefficiency effect. For performing
tests of the relevant null hypotheses, the generalised likelihood
ratio statistic l = 2[l(H0)l(H1)] is employed, where l(H0) is the
log-likelihood value of the restricted frontier model, and l(H1) is
the log-likelihood value of the translog model defined in equation
4. If the null hypothesis is true, the test statistic has approximately
a x2 distribution with degrees of freedom equal to the number of
parameters involved in the restrictions. The test statistic under
the null hypothesis of no-inefficiency effects has approximately a
mixed x2 distribution, and the critical value for this test is taken
from Table 1 of Kodde and Palm (1986). The results for translog
and the sub-models under Battese and Coelli’s (1995) study are
presented in Table 7.2.
 176•Suman Sharma

Table 7.2: Maximum Likelihood Estimates of Stochastic Production Frontier

Variables Model 1 Model 2 Model 3 Model 4 Model 5
Production function
Constant 2.01*** 1.53*** 0.74*** 0.51*** 0.13***
(0.16) (0.16) (0.15) (0.08) (0.08)
Ln(K) 0.03 0.40 0.40 0.11*** 0.12***
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(0.05) (0.05) (0.05) (0.01) (0.01)

Ln(L) 0.90*** 0.63*** 0.73*** 0.76*** 0.73***
(0.06) (0.06) (0.07) (0.02) (0.02)
[Ln(K)]2 0.03*** 0.05*** 0.07***
(0.01) (0.01) (0.01)
Ln(K) * Ln(L) 0.08*** 0.12*** 0.17***
(0.01) (0.01) (0.02)
[Ln(L)]2 0.03*** 0.02* 0.01
(0.02) (0.02) (0.01)
T 0.63*** 0.61***
(0.05) (0.05)
T * Ln(K) 0.09***
(0.01)
T * Ln(L) 0.08***
(0.01)
T2 0.11*** 0.17***
(0.01)) (0.01)
Inefficiency function
Constant 11.35*** 11.04*** 6.05*** 35.22***
(2.67) (2.85) (1.54) (8.60)
Foreign 0.39*** 0.63*** 1.18*** 1.12***
(0.48) (0.58) (1.44) (0.75)
Spillover 95.89*** 98.94*** 161.64*** 150.38***
27.94 (32.16) (12.86) (45.93)
Age 0.04*** 0.06*** 0.01*** 0.06***
(0.01) (0.01) (0.01) (0.01)
Gamma 0.97*** 0.97*** 0.98*** 0.99*** 0.94***
(0.01) (0.01) (0.001) (0.002) (0.01)
Log-likelihood 1286.20 1363.63 1499.06 1579.36 1611.59
Source: Author’s calculations.
Note: Model 1 is a translog production function. Models 2 and Model 3 represent a Hicks-neutral
and a no-technological progress production function, respectively. Model 4 is a Cobb–Douglas
production function and Model 5 represents a no-inefficiency production function. Standard errors
are in parentheses and presented until two significant digits, and the corresponding coefficients
are presented up to the same number of digits behind the decimal points as the standard errors.
*** Denotes significance at 1%.
** Denotes significance at 5%.
* Denotes significance at 10%.
 Foreign Direct Investment and Efficiency •1 7 7

The last row of Table 7.2 presents log-likelihood values

for each functional form. These log-likelihood values are used to
calculate the generalised likelihood ratio statistic, k. The results of
the null hypotheses tests are presented in Table 7.3.

Table 7.3: Tests of Hypothesis of Stochastic Production Frontier

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Test H0 l x21% Conclusion

Hicks neutral ant = 0 154.86 9.21 Hicks neutral
rejected
No-technological at = ant = att = 0 425.72 13.277 No-technolog-
progress ical progress
rejected
Cobb–Douglas ank = at = ant = att = 0 586.32 18.475 Cobb–Douglas
rejected
No-inefficiency l = d0 = dj = 0 650.77 17.755 No-inefficiency
rejected
Source: Author’s calculations from log-likelihood function.

From the results, it is obvious that various sub-models

of the translog are found to be an inadequate representation of
the data, given the specification of the translog model. Therefore,
the estimation results from Model 1 in Table 7.2 are used in the
interpretation of productivity spillovers.
The estimation results of a translog stochastic production
frontier show that the coefficients of labour and capital have
expected positive signs. The positive and highly significant
coefficient of labour confirms the expected positive and significant
output effects of labour while the positive coefficient of capital
turns out to be statistically insignificant. In contrast, the squared
variables of labour and capital are positive and statistically
significant at a 1 per cent level, which indicates an increasing return
to labour and capital. Furthermore, the estimated coefficient of the
interacting variable between labour and capital is negative and
significant at a 1 per cent level, suggesting a no-substitution effect
between labour and capital.
For time variables, the coefficient of time is positive and
statistically significant. The same is not true of the squared time.
Its estimated coefficient is negative and statistically significant. A
non-neutral technological progress towards capital is indicated by
a positive and statistically significant coefficient of the interacting
 178•Suman Sharma

variable between time and capital. The combination of the various

coefficients of variables that involve T determines the movement
of the production frontier over time, with this movement being
positive (technological progress) or negative (technological
regress) depending on values of K, L and T.
A main focus of this study is on the estimated coefficients of
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the inefficiency function in the second part of Model 1 in Table 7.2.

The positive and statistically significant coefficient foreign variable
supports our assumption that, on average, foreign firms achieve
higher efficiency than their domestic counterparts do. The negative
and significant coefficient on the spillover variable in Model 1 in
Table 7.2 implies a positive and significant efficiency spillover in
the drugs and pharmaceutical industry. This result suggests that in
the Indian drugs and pharmaceutical sectors higher foreign share
results in domestic firms utilising their resources in a more efficient
way, which then leads to productivity gains.
The coefficient of a controlling variable, Age, is negative
and statistically significant at a 1 per cent level, indicating that
younger firms have higher inefficiency. To ensure that the inclusion
of foreign firms in the estimation on FDI spillovers does not introduce
bias, this study also estimates the frontier for only domestic firms.
The results are presented in Table 7.4. Interestingly, all coefficients
have similar signs and levels of significance as those for the sample
of all firms. This is not a surprise given the fact that foreign firms
are only 6.84 per cent of the total sample. The negative and highly
significant coefficient of the key variable, spillover, is consistent with
the result for the sample of all firms, suggesting that the finding of
positive FDI spillovers on the technical efficiency of domestic firms
in Table 7.4 is not simply a result of biased estimation.

Table 7.4: Maximum Likelihood Estimates of Stochastic Production Frontier for

Domestic Firms
Variables Model 1 Model 2 Model 3 Model 4 Model 5
Production function
Constant 1.96*** 1.52*** 0.85*** 0.93*** 0.57***
(0.16) (0.15) (0.14) (0.07) (0.08)
Ln(K) 0.01 0.39*** 0.36 0.10*** 0.10***
(0.06) (0.04) (0.05) (0.01) (0.01)
Ln(L) 0.95*** 0.68*** 0.65*** 0.84*** 0.82***
(0.06) (0.06) (0.07) (0.02) (0.01)
(continued)
 Foreign Direct Investment and Efficiency •1 7 9

(continued)
[Ln(K)]2 0.03*** 0.05*** 0.05***
(0.01) (0.01) (0.01)
Ln(K) * Ln(L) 0.08*** 0.13*** 0.15***
(0.02) (0.02) (0.02)
[Ln(L)]2 0.02* 0.02** 0.03***
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(0.01) (0.01) (0.01)

T 0.49*** 0.44***
(0.05) (0.05)
T * Ln(K) 0.08***
(0.01)
T * Ln(L) 0.08***
(0.01)
T2 0.08*** 0.12***
(0.01) (0.01)
Inefficiency function
Constant 6.55*** 7.89*** 23.26** 32.42*
(1.54) (1.93) (7.26) (13.73)
Spillover 72.74*** 74.08** 101.39*** 98.47***
(21.54) (22.18) (36.66) (50.39)
Age 0.11*** 0.12*** 0.04*** 0.05**
(0.03) (0.003) (0.01) (0.02)
Gamma 0.96*** 0.97*** 0.99*** 0.99*** 0.92
(0.01) (0.01) (0.002) (0.003) (0.01)
Log likelihood 1022.18 1083.49 1136.27 1182.53 1222.05
Source as: Author’s calculations.
Note: Model 1 is a translog production function. Models 2 and Model 3 represent a Hicks-neutral
and a no-technological progress production function, respectively. Model 4 is a Cobb–Douglas
production function and Model 5 represents a no-inefficiency production function. Standard
errors are in parentheses and presented until two significant digits, and the corresponding
coefficients are presented up to the same number of digits behind the decimal points as the
standard errors.
*** Denotes significance at 1%.
** Denotes significance at 5%.
* Denotes significance at 10%.

The hypothesis H3 is tested with the help of the Herfind-

ahl–Hirschman Index (HHI). The HHI is a measure of the size of
firms in relation to the industry and an indicator of the amount
of competition among them. The HHI is measured as: ni1( p2i )
where pi  qi Q where qi is the sales of the ith firm, Q is the total
sales of the industry and n is the no. of the firms in the industry.
 180•Suman Sharma

Higher concentration is an inverse measure of static competition

that can protect inefficient firms. However, higher concentration
can also be the result of dynamic competition among firms of dif-
ferential efficiency that removes inefficient firms from the indus-
try as argued by Demsetz (1973) and Peltzman (1977). The first
argument suggests that HHI is associated with greater inefficiency,
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while the latter argument suggests that HHI is associated with

lower inefficiency. The estimated maximum likelihood parameters
of a stochastic production function for productivity and compe-
tition are presented in Table 7.5. The spillover variable without

Table 7.5: Maximum Likelihood Estimates of Stochastic Production Frontier with

Inefficiency Coefficients HHI and HHI* Spillover

Variables Coefficient Standard Error t-ratio

Production function
Constant 22.05 0.15 213.52***
Ln(K) 0.02 0.05 0.45
Ln(L) 0.91 0.06 14.73***
[Ln(K)]2 0.03 0.01 4.70***
Ln(K) * Ln(L) 20.08 0.02 23.92***
2
[Ln(L)] 0.03 0.01 3.76***
T 0.62 0.05 13.33***
T * Ln(K) 20.09 0.01 211.98***
T * Ln(L) 0.08 0.01 10.82***
2
T 20.11 0.01 29.94***
Inefficiency function
Constant 220.67 6.93 22.98***
HHI 20.08 0.02 23.67**
HHI spillover 26.85 2.90 22.36**
Gamma 0.98 0.01 139.01***
Log likelihood 21293.76
Source: Author’s calculations.
Note: Coefficient, standard errors and t-ratio are presented until two significant digits.
***Denotes significance at 1%.
**Denotes significance at 5%.
* Denotes significance at 10%.
 Foreign Direct Investment and Efficiency •1 8 1

interacting with HHI is excluded from the estimation because of

multi-collinearity with the interacting variable. Each estimated
parameter of production functions shown in Table 7.5 has a similar
sign and significance as in the baseline model shown in Table 7.2.
In the inefficiency function, the negative coefficient of HHI indi-
cates that concentration among firms in the sector decreases the
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inefficiency of firms, which is consistent with the argument that

concentration is a result of dynamic competition that removes
inefficient firms. The negative coefficient HHI* Spillover suggests
that higher concentration is associated with larger spillovers from
foreign presence.
The estimated parameters of productivity spillovers and
absorptive capacity are presented in Table 7.6. The focus of analysis
is the inefficiency function. The coefficient R&D is negative and
significant at the 1 per cent level, suggesting that firms with R&D
expenditure, on average, have higher efficiencies compared to
those without R&D expenditure. This finding is similar to that
of Todo and Miyamoto’s (2006) study of the overall Indonesian
manufacturing sector and confirms that firms’ absorptive capacity
determines productivity spillovers from FDI, as argued by
Kathuria (2000, 2002). The negative coefficient of the interacting
variable between R&D and spillover suggests that firms with R&D
expenditure gain more spillovers from foreign firms. Therefore, it is
possible to infer that firms with R&D expenditure can reap benefits
from foreign firms’ presence by upgrading their knowledge and
creating new innovations.

Table 7.6: Maximum Likelihood Estimates of Stochastic Production Frontier

with Inefficiency Coefficients RD and RD* Spillover
Variables Coefficient Standard Error t-ratio
Production function
Constant 1.90 0.15 12.64 ***
Ln(K) 0.01 0.05 0.19
Ln(L) 0.88 0.06 14.73 ***
2
[Ln(K)] 0.03 0.01 4.75 ***
Ln(K) * Ln(L) 0.03 0.01 3.91 ***
[Ln(L)] 2
0.08 0.02 3.84 ***

(continued)
 182•Suman Sharma

(continued)

T 0.61 0.05 13.13 ***

T * Ln(K) 0.09 0.01 12.77 ***
T * Ln(L) 0.08 0.01 11.04 ***
T2 0.10 0.01 9.76 ***
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Inefficiency function
Constant 9.03 1.22 7.39 ***
RD 7.04 0.63 11.10 ***
RD * Spillover 58.82 9.85 5.97 ***
Gamma 0.96 0.00 222.28 ***
Log likelihood 1275.40
Source: Author’s calculations.
Note: Coefficient, standard errors and t-ratio are presented until two significant digits.
*** Denotes significance at 1%.
** Denotes significance at 5%.
* Denotes significance at 10%.

Conclusion
The FDI policy was considerably liberalised during the 1990s as
a part of reforms implemented since 1991. This change in the
attitude was based on the realisation that the knowledge brought
in by firms ultimately spilled to the rest of the economy. It is in
this context that this study examines the productivity spillovers
from FDI in the Indian drugs and pharmaceutical industry by
using a firm-level panel data covering the period 2000–2001 to
2007–8. This chapter uses the stochastic frontier production
function following Battese and Coelli (1995) to test the hypothesis
that ‘foreign-owned firms are more efficient than domestic firms’.
Results confirm our hypothesis that, on average, foreign firms
achieve higher efficiency in comparison to the domestic firms.
This study also examines the intra-industry productivity
spillovers through the spillover variable, and the roles of competition
and R&D in extending spillovers from FDI. The empirical results
show that intra-industry productivity spillovers are present in the
sector. It also shows that competition facilitates spillovers from a
foreign presence in the industry. Firms with R&D expenditure receive
more productivity spillovers than those without R&D expenditure.
This suggests policies for strengthening the absorptive capacity of
domestic firms through investing in knowledge and human capital
 Foreign Direct Investment and Efficiency •1 8 3

formation may be superior to policies that provide concessions for

FDI. The policies should be framed in such a manner that they
not only attract FDI but also benefit domestic firms, build modern
infrastructure, increasing and strengthening the institutions for
accelerating and sustaining economic growth.
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Note
1. The FRONTIER software uses a three-step estimation method to ob-
tain the final maximum-likelihood estimates. First, estimates of the
a-parameters are obtained by OLS. A two-phase grid search for g is
conducted in the second step with a-estimates set to the OLS values
and other parameters set to 0. The third step involves an iterative pro-
cedure, using the Davidon-Fletcher-Powell Quasi-Newton method to
obtain final maximum-likelihood estimates with the values selected
in the grid search as starting values.

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 8
Financial Decoupling of Emerging Asset
Markets from Japan and the US
Peter J. Morton
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I
n the earliest stages of the present financial crisis, as US
housing prices began to weaken and signs of stress first
appeared in the markets for mortgage-backed securities, the
extent of the threat to the global economy was not immediately
reflected in the world’s equity markets. In the US itself, stock prices
continued to make modest, intermittent advances through the end
of 2007, while Asian emerging market indexes showed more rapid
advances consistent with the region’s accelerated development.
The implication, at least for international investors, was reassuring:
one region’s growth offsets another region’s stumbles. From an
economist’s longer-term perspective the same principle might also
apply to real economic relations of growth, development and trade.
This reassuring sense of a future in which periods of prosperity and
recession would become more independently distributed in both
time and location, became associated with the term ‘decoupling’.
Seen from the perspective of 2011, much of the evidence for
financial markets’ decoupling seems invalid, and that which
remains is better described as ‘exciting’ rather than reassuring.
The graphical display in Figure 8.1 shows that despite
early evidence of continuing appreciation during 2007, the
emerging market indices, particularly those based in Bombay
and Shanghai, eventually declined enough to briefly overtake the
S&P before resuming their earlier interrupted advances. In fact,
measured in log terms relative to March 2007, the spread between
highest and lowest values attained during the crisis period was
smaller in the S&P’s case (0.75 log) than for Bombay (1.05
log), Shanghai (1.14 log), or Singapore (0.91 log). Decoupling
seems to hold, if at all, only in a very long-term sense where
it is associated with increased short-term volatility rather than
with any reduction of risks through increased diversification of
the global portfolio.
 Financial Decoupling of Emerging Asset Markets from Japan and US •1 8 7

Figure 8.1: S&P vs Three Asian Stock Indices (Log Scale from March 2007)

80.000

60.000
Cumulative change (⫻ 0.01 log)

40.000
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20.000

0.000
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45
⫺20.000

⫺40.000

⫺60.000

⫺80.000

⫺100.000
Months Elapsed
SP BS
SS ST

Source: Monthly Data from Yahoo Financial. SP: [Link]

HistoricalPrices (accessed 20 January 2011); BS: [Link]
hp?s^BSESNHistoricalPrices (accessed 20 January 2011); SS: [Link]
com/q/hp?s[Link]HistoricalPrices (accessed 20 January 2011); ST: [Link]
[Link]/q/hp?s^STIHistoricalPrices (accessed 20 January 2011).
Note: SP  Standard & Poors 500, BS  Bombay Stock Exchange, SS  Shanghai Stock
Exchange, ST  Straits Times (Singapore).

The United States has for several decades played the role
of the world’s consumer — a locomotive for export-led growth in
Asia, financed as well by capital inflows from Asia. Many times in
the past, when US demand has faltered, Asian growth has slowed.
But the cumulative effect of this necessarily uneven growth must
be an increase in relative size and weight for emerging Asia. The
situation cannot endure indefinitely, given the changing balance
between Asia’s ability to produce and America’s power to purchase.
One possibility is that growth will simply not be able to continue
at its recent pace. Another possibility is that other sources of final
demand will be found elsewhere within the region, in other regions,
or in the internal markets of the emerging economies themselves.
In any case, the issue of what form the transition will take, and
how smoothly it will proceed, is of practical interest to all market
stakeholders. It is of special interest to economists because it seems
likely to constrain the ability to design appropriate institutional
 188•Peter J. Morton

mechanisms for a smooth transition, and it is naturally of pecuniary

interest to investors of all sorts. The purpose of this research is to
examine publicly available long-term financial and economic data
to determine whether the larger, older markets have somehow
retained the ability, despite the decline in their relative size, to
disrupt or otherwise influence events in the emerging markets.
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Background
It is difficult to account for the invention of the metaphoric term
‘decoupling’, because its origins were those of a business community
buzzword, and it was not used in the economics journals until
quite recently. I speculate that the term originated with financial
organisations anxious to persuade customers to invest in newly
developed exchange-traded funds (ETFs), designed to track the
performance of emerging markets. In engineering language, a
train of railway cars can be ‘coupled’ to a locomotive and drawn
forward. The metaphor is sometimes applied to international
economic relationships where a single dominant economy serves
as an engine of growth for its trading partners. In asset markets,
where risk-averse investors prefer for the different holdings in their
portfolios not to all move in the same direction simultaneously, the
corresponding ‘decoupling’ metaphor has been invoked to describe
the maturing of the world’s emerging markets to the point where
they can move independently and not all follow the same leader.
The correlation of financial and economic variables across
national boundaries reflects the ease or difficulty of conducting
international business. Greater integration by itself implies a
shared experience both of economic growth and the setbacks that
punctuate it. But in the Asia-Pacific region, rapid growth has also
led to a less centralised distribution of production and demand.
Instead of being dominated by the United States and later also
by Japan, the region now has three national economies among
the world’s five largest, and many smaller and rapidly growing
economies that also account for an increased share of regional
GDP.1 Integration has encouraged growth, and growth has led to a
multi-polar system, but the implications of integration and multi-
polarity for systemic stability appear to pull in opposite directions.
This chapter performs some simple experiments with noisy data to
 Financial Decoupling of Emerging Asset Markets from Japan and US •1 8 9

examine one important issue bearing on whether the net effect is

to resonate or dampen cyclical instabilities. Evidence from changes
in asset prices and real growth rates over two decades suggests that
since the turn of the century the regional economies have become
even more sensitive to disturbances originating in the United
States, and also to those originating in Japan and China. We might
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consider that the relative abilities of economic events originating in

each separate economy to influence those occurring elsewhere in
the region should have a finite sum of one. But even as America’s
relative economic weight in the international economy has
decreased, it is still possible that the absolute impact of American
developments on other economies may have increased. The fact
that for half a century the size of the American economy has been
reduced relative to that of China or Japan or India, does not in any
sense guarantee that events in those places are more decoupled
from events in the US. This could fail to be the case if the region
as a whole has become less stable, or if the American economy has
become less stable in relation to its partners, or if the structure of
economic linkages between the regional economies has changed
to facilitate the transmission of shocks, at least in that particular
direction.
In Eastern and Southern Asia, recent decades have seen
the opening up of China, economic liberalisation in India, the
establishment of the WTO, revolutionary advances in electronics
technology and the internet, and a period of relative peace
conducive to commercial development. Reduction of legal and
technical barriers to movement of goods, services and information
has taken place under the general heading of globalisation. Kawai
(2005) provides a detailed institutional account of how the East
Asian region in particular has become more interdependent since
1980, and cites the 1997–1998 financial crisis as an example of
how this has worked to facilitate the transmission of shocks from
one economy to another within the region.2
If growth had progressed at equal rates for all countries,
then globalisation might be expected to have led to an increased
coordination of market behaviours throughout the region without
changes in their relative size. However, the distribution of economic
activity also became more dispersed as growth has proceeded
most rapidly in China, India and the regional newly industrialised
countries (NICs), at the expense of the United States. In fact,
 190•Peter J. Morton

during the two-decade period under closest study here, Japan had
already achieved the status of the world’s second-largest economy,
and its location in or near East Asia gave it an economic influence
comparable to that of the US. Subsequently, Japan’s weight in
the region has likewise declined. Table 8.1 illustrates both trends,
showing that on a purchasing power parity basis, during 1990–
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2009, Japan’s nearly 10 per cent decline in regional GDP share and
the US’s share decline of about 13 per cent were matched by the
increased shares accounted for by other regional Asian economies,
principally China, but also including Korea, Indonesia, Singapore,
Malaysia, Taiwan, Hong Kong, and India. The volume of intra-
regional trade grew much more rapidly than GDP during these two

Table 8.1: Background Percentage Measures of

Declining US–Japanese Economic Dominance

% of Group Total
% of Group GDP (PPP basis)
Trade
1990 2009 Change 1990 2008 Change
Australia 2.73 2.37 0.37 3.50 2.80 0.70
China 8.34 26.06 17.72 4.66 22.37 17.70
HK 0.90 0.91 0.01 8.28 9.07 0.79
India 7.08 10.83 3.75 1.59 4.44 2.85
Indonesia 2.47 2.77 0.30 2.74 2.31 0.43
Japan 21.55 11.96 9.59 26.42 14.60 11.82
Korea 3.26 3.92 0.67 4.82 8.35 3.52
Singapore 0.48 0.72 0.25 NA NA NA
USA 53.20 40.48 12.72 47.98 36.06 11.92
% of Group Total % of Group Total
Exports Imports
1990 2008 Change 1990 2008 Change
Australia 3.21 2.01 1.19 3.78 3.64 0.14
China 5.36 25.82 20.46 3.99 18.70 14.71
HK 8.73 9.22 0.50 7.84 8.91 1.07
India 1.60 4.14 2.54 1.59 4.75 3.17
Indonesia 3.02 2.48 0.53 2.48 2.13 0.35
Japan 27.52 16.71 10.82 25.35 12.36 12.98
Korea 4.08 8.91 4.83 5.55 7.75 2.21
USA 46.49 30.71 15.78 49.43 41.75 7.67
(continued)
 Financial Decoupling of Emerging Asset Markets from Japan and US •1 9 1

(continued)
% of Total Market Capitalisation % of Total Value of Traded Stocks
1990 2009 Change 1990 2000 2008 Change
Australia 1.71 4.26 2.55 1.13 0.60 1.91 0.78
China 0.00 16.97 16.97 0.00 1.92 10.25 10.25
HK 1.31 7.76 6.45 0.98 1.01 3.05 2.07
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India 0.61 4.00 3.39 0.62 1.36 1.97 1.35

Indonesia 0.13 0.60 0.48 0.11 0.04 0.21 0.09
Japan 45.88 11.44 34.44 45.13 7.17 11.02 34.11
Korea 1.74 2.83 1.09 2.14 2.84 2.75 0.61
Singapore 0.54 1.05 0.51 0.57 0.24 0.51 0.06
USA 48.08 51.08 3.00 49.32 84.82 68.34 19.02

Source: International Monetary Fund, Direction of Trade Statistics (DOTS), 1988–2009,

collated by the author from Taiwan’s Ministry of Education database. World Bank, World
Development Indicators, 2010, collated by author from World Bank’s database, Washington
D.C. Series [Link] , [Link], [Link], [Link] and
[Link].

decades, and the movement away from a US-centered regime is best

illustrated by the more than 15 per cent reduction of the American
share of total intra-regional exports from 46.49 per cent in 1990
to 30.71 per cent in 2008. During the same period the US import
share declined from 49.43 per cent to 41.75 per cent. In overall
trade volume, Japan’s reduced trade presence was somewhat more
pronounced than the decline in her GDP share, and China’s share
increased by almost 18 per cent from 1990 to 2008.
Petri (2006) tries to put into perspective the importance
of relative size and trade volume as determinants of economic
interdependence by emphasising the parallel importance of
industrial structure, most importantly that of the region’s heavy
dependence on the electronics industry and the continued
dependence on final demand located overseas. To the extent that
components are increasingly shipped across intra-Asian borders
prior to final assembly and overseas export to American and
European markets, the aggregate trade shares may exaggerate the
actual degree of regional decoupling involved.
This is somewhat in contrast to the view of Kim et al.
(2011), who also cite intra-regional trade intensity as the most
important determinant of regional interdependence and, with
respect to overseas markets, suggest that events originating in Asia
 192•Peter J. Morton

have actually increased influence elsewhere, rather than emphasis-

ing a one-way dependence on overseas final demand.
In spite of the institutional measures cited by Kawai
(2005), Petri finds that a clear bias towards intra-Asian regional
trade intensity only appears in the data after 2000, and he suggests
that it is attributable largely to the wider dispersal of electronics
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manufacturing activity throughout the Far East. In his view, the

application of electronics-based information and communication
technologies made it increasingly easy for companies to manage
large numbers of overseas production facilities, leading to their
relocation in China and Southeast Asia, mainly at the expense of
Japan. For this reason, a wider distribution of incomes from this
industry would not immediately confer resistance to disturbances
outside the region to the extent that these disturbances impacted
the industry’s final demand. This analysis appears not too pes-
simistic with regard to the longer-term prospects of decoupling
because income growth in Asia and possible market saturation in
Europe and the United States should soon shift the locus of final
demand closer to home.
Another electronics-related structural factor cited by
Kumakura (2006) concerns the sectoral dispersion of final demand
away from business investment and towards less volatile household
consumption spending. To the extent that the analysis holds true
though, there might be a tendency to initially underestimate the
transmissibility of a disturbance originating in the market for
home mortgages.
In practice, the observed stability of an Asia-Pacific or even
a world economic portfolio should depend not only on the relative
size of the various national economies and the industrial structure
of the linkages among them, but also on a third ‘S’, the severity of
the disturbances that impact them. In their attempt to explain the
sudden evident re-coupling of emerging markets to the US in 2008,
Dooley and Hutchison (2009:1332) phrase the problem as follows:
‘it is not clear whether the structural linkages between the U.S.
and emerging markets have changed or whether the frequency,
importance and magnitude of the events emanating from the U.S.
have changed.’
Empirically, the issue is also a difficult one to resolve with
a finite number of observations because of the need to divide the
sample into sub-periods for comparison purposes. The briefer
 Financial Decoupling of Emerging Asset Markets from Japan and US •1 9 3

the sub-periods chosen for examination, the more likely that the
transmission patterns observed in each one will be dominated
by a particular incident, with no objective way to compare the
inherent severities of each. As in the case of the 2008 financial
crisis, the effects of a shock will tend to emanate from the place of
origin to impact upon the associated economies. Although a pair
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of countries may organically be equally susceptible to each other’s

disturbances, the observed pattern of influence often runs in one
direction or the other for extended periods, so that it is difficult
to independently measure the ease of transmission. An interval
too short to offer evidence from multiple and varied disturbances
may give misleading results to suggest that the system is passively
organised around one central instigator.
Without an easy way to control for this important variable,
theory offers no practical formula to predict the net effect of
simultaneously increasing integration and dispersion on the
synchronicity of regional economic movements. In the abstract
we can calculate the response of portfolio risk to changes in the
weighting of the imperfectly correlated assets they contain. It
is easy to show that in the simplest case where the specific risk
of each asset is the same, the investor can minimise the overall
risk by weighting each asset equally. By extension, after making
enough simplifying assumptions, there is a sense in which a group
of interdependent economies might achieve the stablest aggregate
performance when they are of equal size. If rates of return vary,
the optimal portfolio will want to put additional weight on the
asset with the higher expected return, which is just what unequal
rates of economic growth eventually accomplish. This insight
is too simple to be overlooked by an international investor, but
for a typical non-wealthy citizen with limited ability to diversify
internationally, the only real issue is what set of arrangements will
achieve the most desirable balance between growth and stability
in the home country.
The financial crisis is only the most recent and most
wrenching discontinuity to impact the region during the period
since 1990, but other serious disruptions have taken place. Two
other US recessions in the early 1990s and again a decade later,
the collapse of Japan’s 1980s asset bubble, and the Asian financial
collapse of 1997–98 have all had the opportunity to spread their
effects throughout the region.
 194•Peter J. Morton

Evidence for Financial Decoupling

Because asset markets have so often been at the source of
the initiating shock triggering global instability, and because
their pricing data is more easily measured, more frequent, and
quicker to respond than most macroeconomic series, it presents
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a convenient venue in which to examine the degree of coupling

between economies. However, the data have important limitations
— it can be difficult to associate quantity measures with prices for
making size comparisons between asset markets. Measures such as
trading volume and total capitalisation present many problems of
double-and/or fractional-counting. The last two panels of Table 8.1
attempt to provide a contextual background of US and Japanese
financial dominance in the region equivalent to the trade and
finance information presented in the preceding panels. Erosion is
more clearly evident in the case of Japan, which, as estimated by
the World Bank, saw its share of total market capitalisation drop
by three-quarters between the bubble-inflated initial year of 1990
and 2009. The main US stock bubble peaked around the turn of
the century, and by 2009, US market capitalisation still claimed
a regional share 3 per cent greater than it had in 1990. Likewise,
estimates of the total value of traded stocks indicate significant
share gains for the US and China, along with share losses for Japan.
The expectational nature of stock price movements —
the fact that they represent anticipated effects on future earnings
— makes it difficult to draw connections to prior or concurrent
developments in the real economy. With the increased ease
of transmitting large amounts of information internationally,
correlations among stock index movements reflect a momentary
consensus of opinion or conjecture among a well-informed
financial elite, rather than the actual economic effects as they
will eventually play out. A slower adjustment process would
actually make it easier to discriminate between causes and effects.
In an event-response study of 14 emerging markets with special
attention paid to Mexico, Dooley and Hutchison (2009) cite the
extreme rapidity with which news events from the United States
were noted and responded to by foreign asset markets. Hooy and
Lim (2010) calculated a ‘delay’ measure of market efficiency based
on the rate at which the risk-adjusted return to a particular market
index reflected changes in the risk-adjusted return to the world
 Financial Decoupling of Emerging Asset Markets from Japan and US •1 9 5

portfolio. In a study of 49 local stock indices, they found that even

in most emerging markets, more than half of the eventual local
adjustment to world index movements was accomplished in the
contemporaneous quotation of the local index. The implication
for the present research is that temporal priority will be of little
use in tracing the transmission of disturbances from one market
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to another even when using large, frequently sampled data sets.

Simple correlations are still measurable, but Hooy and Lim, citing
Adler and Dumas (1983), maintain that ‘it is inappropriate to use
the correlation coefficient of broad market indices as a measure
of stock market integration’ for economies with different industry
structures,. Pukthuantong and Roll (2009) develop alternative
integration measures that appear to show that while market
correlations have increased only a little, other evidence suggests
much larger increases in integration.
In the present chapter we are not precisely concerned with
measuring stock markets’ integration per se, but rather with their
observed interdependence and the transmissibility of disturbances
from one market to another. As such, the chapter relies heavily on
contemporaneous correlations and infers the direction of causation
based on the known sequence of events and the relative size of the
economies in which the different exchanges and their indices are
embedded. An illustrative case may be found in that of Singapore
and the Straits Times index.
Did the increased weightings dispersion reduce these large
countries’ economic impact on the other markets in the Asia-Pacific
region? It is difficult to use the asset price information to establish
cause and effect between counterparties of comparable size, but
as a simplification measure we closely examined the connections
between the largest regional markets and a single smaller one based
in the city-state of Singapore. Table 8.2 shows the results of a series
of regressions in which the monthly log differences for the Straits
Times index were regressed against those for nine neighbouring
exchanges, along with a lagged value of the Straits Times itself.3
Since Singapore’s asset markets are proportionately large relative
to the country itself, the hope was that their movements would be
strongly sensitive to external stimuli and that the issue of possible
bi-directional causation would be of reduced importance. Since
Singapore is politically independent, with cultural ties to many
large regional powers while geographic distance prevents it from
 196•Peter J. Morton

being dominated by any single one, it was likewise hoped that its
course could be a sensitive barometer to the causal power and
influence of its neighbour and competing exchanges.

Table 8.2: Monthly Straits Times Market Index Log Change Regressed on
Neighbour Indices
(Early  pre-2000, Late  post-2000)
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Durbin Concur- St.

DV Period Months R2 Coef (t)
Watson rent IV Coef
ST Early 122 0.30 1.98 GSP 1.20 7.06 0.54
ST Late 130 0.50 2.34 GSP 0.96 10.88 0.69
ST Early 122 0.20 2.06 NIK 0.49 5.42 0.45
ST Late 130 0.38 2.27 NIK 0.65 8.13 0.58
ST Early 109 0.33 2.05 AO 1.12 7.18 0.57
ST Late 130 0.65 2.08 AO 0.89 14.86 0.81
ST Early 122 0.58 2.00 HS 0.76 12.67 0.76
ST Late 130 0.61 2.53 HS 0.78 13.55 0.76
ST Early 31 0.24 2.32 KS 0.39 2.93 0.49
ST Late 130 0.50 2.29 KS 0.53 10.40 0.69
ST Early 31 0.40 1.97 TW 0.96 4.27 0.63
ST Late 130 0.42 2.32 TW 0.51 9.06 0.62
ST Early NA SSE
ST Late 130 0.14 2.12 SSE 0.26 3.97 0.33
ST Early 30 0.12 2.04 BSE 0.58 1.89 0.35
ST Late 130 0.54 2.13 BSE 0.57 11.70 0.73
ST Early 74 0.56 2.02 KL 0.59 9.55 0.75
ST Late 130 0.42 2.24 KL 0.83 9.09 0.65
Source: Monthly closing historical price data obtained from Yahoo Financial. ([Link]
[Link]/intlindices, accessed 20 January 2011). Exchange Rates are from Pacific Exchange
Rate Service. ([Link] accessed 20 January 2011).

Note: Both the monthly returns used in these estimations and the daily returns used in Figures
8.2 and 8.3 were obtained as log differences of dividend-adjusted index values, and data at
both frequencies were determined to be stationary based on evidence from the test procedure
described by Cuthbertson and Nitzche (2004). Further details are provided in a brief appendix
to this report.

Some series, notably the Shanghai SSE, had little data

available prior to 2000, so it was only possible to estimate a model
for the ‘late’ decade, 2000–2010. For those where ‘early’ and ‘late’
estimates could be made, the standardised coefficients in the right-
 Financial Decoupling of Emerging Asset Markets from Japan and US •1 9 7

hand column increased in the ‘late’ period, or else remained essentially

unchanged, as in the cases of Hong Kong and Taiwan.4 Only in the
case of the neighbouring Kuala Lumpur exchange did the measured
‘effect’ of the independent variable diminish significantly. In spite of
the much-diminished economic weight of Japan, as documented in
Table 8.1, the Nikkei’s measured ‘influence’ on (correlation with) the
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Straits Times increased by nearly as much as that of the Standard

& Poors’ GSP. The unstandardised results showed more volatility,
and with only one wholly independent variable in each equation,
one could rank the influence to the IVs according to other metrics,
like their absolute t-values, or even the R2 values. This chapter will
continue to give most attention to the standardised coefficients
precisely because of their stability and relative intercomparability.
To acquire a more detailed picture of the changing
influence of the different independent variable indices, it was
desirable to estimate separate coefficients at more finely divided
sub-intervals. This was done for each separate year of the sample
period. In several noteworthy cases, daily closing prices were
obtained so that interactions between the index values could be
estimated based on the largest possible number of observations.5
Rather than a tabular presentation, the estimated coefficients can
be displayed graphically, as shown in Figures 8.2 and 8.3.
Figure 8.2 shows clearly that Japan’s diminished regional
economic profile was not accompanied by strong evidence of
decoupling of the Nikkei’s daily returns from those of the Straits
Times. Likewise the S&P coefficients exhibit a pattern of vague and
intermittent increase after declining from briefly high initial levels
very early in the 1990s. There is also some suggestion that the
intervals of stress surrounding the 1998 and 2008 crises produced
temporary peaking of the ‘coupling’ coefficients for both countries
vis-à-vis Singapore, while the periods of relative stability and
growth were marked by at least short-term decoupling.
In Figure 8.3, the Morgan Stanley Far East Index, and the
Straits Times (with which it shares some overlapping components),
are shown to share in common the same broad suggestion of a long-
term increase in their degree of coupling to the S&P. From this it
appears that the Straits Times’ connection to the S&P is broadly rep-
resentative of the larger East Asian Region. Less clearly than in Figure
8.2, there is also some suggestion that evidence for closer coupling
becomes most pronounced in periods of international stress.
 198•Peter J. Morton

Figure 8.2: Standardised Coefficients from Daily ST Closing Values, Regressed on

GSP and Nikkei, by Years, 1991–2010

0.8
Standardized coefficients

0.7
0.6
0.5
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0.4
0.3
0.2
0.1
0
90

00

10
98

08
92

02
96

06
94

04
19

20

20
19

20
19

20
19

20
19

20
Year
NIK
GSP

Source: [Link]
NIK: [Link] (accessed 20 January 2011)

Figure 8.3: Graph of Standardised Coefficients from ST and MSFE Regressed on

GSP—Daily Data by Years, 1990–2010

0.7

0.6

0.5
Coefficients

0.4

0.3

0.2

0.1

0
90

00

10
98

08
92

02
96

06
94

04
19

20

20
19

20
19

20
19

20
19

20

Year
MSFE
ST

Source: [Link] (accessed 20 January

2011); MSFE: Morgan Stanley Far East Stock Index (as cited in note 5) obtained via Taiwan
Ministry of Education Computing Center for the period 1 January 1990 to 17 September 2010.
 Financial Decoupling of Emerging Asset Markets from Japan and US •1 9 9

To further clarify the relative influence of the three large

country indices, and to isolate the influence of the financial crisis
‘tsunami’ on the results, the later post-2000 sample period of the
monthly Table 8.2 data set was next divided into three shorter
intervals: Thus, period zero begins in 1990 and comprises all
months prior to January 2000, while periods 1, 2, and 3 subdivide
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the post-2000 data into four-year sections, with a necessary one-

year overlap because the total amounts to only 11 years from the
beginning of 2000 to the end of 2010. The data from 2003 were
included both at the end of period 1 and the beginning of period 2.
Period 1 contains the years 2000–2003, period 2 contains 2003–6
and period 3 includes the financial crisis of years 2007–10. In these
latter three periods, the Shanghai Composite was added as a third
independent variable as the Table 8.1 background data to reflect
that the bipolar nature of the Asia-Pacific economy had become,
in many respects, tri-polar by that time. Results are found in Table
8.3a.
Where the Table 8.2 regressions were constructed by
the separate pairing of one major independent index with one
dependent index, the Table 8.3 regressions now force the two
(three) independent indices to contend directly in explaining the
movement of each target index. One unusual consequence of the
introduction of the Shanghai Composite in period 1 is that it makes
its debut taking a negative coefficient value in that period. True
sustained negative correlations are not common among companies,
and presumably ought to be even less common among aggregations
of companies, even across national boundaries. One might interpret
this as revealing some competition for globally mobile capital;
perhaps initially it is diverted to the Shanghai exchange from other
destinations. The contribution of the Shanghai index moves in a
generally positive direction in later periods, although it does not
yet match the explanatory weight of the GSP and Nikkei indices.6
Table 8.3b repeats the ‘small country vs large country’
inferred causation approach with another city-state-based index,
this time more closely linked to China than Singapore. It was spec-
ulated that the Hang Seng results would offer an early indication
that Hong Kong is on the path towards being the first of the exam-
ined economies to reap genuine decoupling benefits as a conse-
quence of multi-polarity. Based on the results, it appears that the
touted rivalry between the Hong Kong and Shanghai exchanges
 200•Peter J. Morton

Table 8.3a: Period Estimates of Relative Influence of S&P,

NK and Shanghai Indices on Straits Times
(Period 0  Pre-2000, Period 1  2000–2003,
Period 2  2003–2006, Period 3  2007–2010)

Period Mths Adj-R2 Durbin IV Coeff (t) Scoeff

0 120 0.34 2.03 Lag DV 0.01 1.57 0.11
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GSP 0.93 5.16 0.42

NK 0.31 3.48 0.28
1 47 0.33 2.40 Lag DV 0.01 .04 .01
GSP 0.63 3.51 0.48
NK 0.22 1.53 0.21
SS 0.27 1.92 0.24
2 48 0.41 2.23 Lag DV 0.26 2.20 0.26
GSP 0.59 3.45 0.43
NK 0.22 2.49 0.31
SS 0.02 0.31 0.36
3 48 0.76 2.29 Lag DV 0.13 1.72 0.13
GSP 0.52 3.07 0.36
NK 0.52 3.51 0.40
SS 0.16 2.70 0.22
Source: Results are based on author’s calculations using monthly data from:
ST: [Link] (monthly, accessed
20 January 2011)
GSP: [Link] (monthly, accessed
20 January 2011)
NIK: [Link] (monthly, accessed
20 January 2011)
SS: [Link] (monthly, accessed
20 January 2011).

is not really a zero-sum game; their fortunes are becoming more

and more positively associated with each other. Here, the sign of
the period 1 coefficient was positive, but it did not become signifi-
cantly so until period 3.
Restricting attention to periods 1 and 2 prior to the
financial crisis, the Table 8.3 results reveal that only in period 1
did the Nikkei’s coefficient appear to clearly play a more important
role than that which it had played in the 1990s results for period 0.
 Financial Decoupling of Emerging Asset Markets from Japan and US •2 0 1

Table 8.3b: Multi-period Estimates of Relative Influence of GSP,

NK and Shanghai Indices on Hang Seng

Period Months Adj-R2 Durbin IV Coeff (t) Beta

0 120 0.25 1.99 Lag DV 0.02 0.19 0.02
GSP 1.02 5.33 0.46
NK 0.13 1.35 0.12
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1 47 0.56 1.69 Lag DV 0.09 0.85 0.09

GSP 0.70 5.09 0.56
NK 0.29 2.58 0.29
SS 0.14 1.23 0.13
2 48 0.34 1.88 Lag DV 0.00 0.03 0.00
GSP 0.90 4.05 0.53
NK 0.10 0.86 0.12
SS 0.12 1.75 0.21
3 48 0.71 1.74 Lag DV 0.02 0.22 0.02
GSP 0.36 1.92 0.26
NK 0.50 3.09 0.39
SS 0.27 4.15 0.37
Source: Results are based on author’s calculations using monthly data from Hang Seng: http://
fi[Link]/q/hp?s5^HSI1Historical1Prices (monthly, accessed 20 January 2011)
Also see GSP, NIK, SS as referenced in Table 8.3a.

But the Nikkei’s influence definitely increases in period 3, along

with that of the S&P, even eclipsing that of the S&P in the case of
the Hang Seng, as seen in Table 8.3b.

Conclusions
Data availability makes regional coupling of asset prices easier to
measure than that of real variables like GDP movements, but the
results may be more difficult to interpret. Both the United States and
Japan account for much smaller shares of output and traded output
within the East Asian region than they did 20 years previously. But
their stock market indices appear, if anything, to be somewhat more
closely coupled to those of the smaller regional economies in the
most recent decade than they were in the one prior. Based on both
types of evidence, this observation probably applies even more
 202•Peter J. Morton

strongly to Japan’s case than to that of the US, but 2008’s financial
meltdown has at least temporarily returned the US, not in a good
way, to its role as a prime mover in Asia-Pacific economic affairs.7 The
data considered here do not shed very much light on the recovery
period which is still far from complete, but if Asia continues to
recover faster than the United States, a similar analysis conducted in
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a year or two might present a stronger case for decoupling. Japan’s

apparently undiminished influence must be based on more than
sheer size, where it enjoys a much smaller advantage than before,
so in the absence of a convincing third explanation, the evidence
suggests that the regional environment has become increasingly
suited to transmitting the effects of disturbances from one economy
to another.
In China’s case too, there is evidence of increased coupling
to the smaller regional economies, but its influence is still much
less than that of the other two big players. The structure of China’s
production appears to place it more directly in competition with some
of the regional economies in Southeast Asia, with whom it competes
for investment capital, and perhaps for different reasons, with Taiwan.
This study has not tried to examine economic relations
between the Asia-Pacific region and other parts of the world,
but the implication for the world economy as a whole seems
to be that the integrating factors that have disproportionately
facilitated growth for the emerging economies of Asia have
not led to increased overall stability by the averaging out of
disturbances emanating from different places. Instead, it seems
to have orchestrated the effects of those disturbances into a more
pronounced regional business cycle.8 The validity of extending
such a conclusion to the world economy as a whole depends on
whether the Asia-Pacific region is a ‘typical’ region whose behaviour
has valid parallels in Europe, Latin America and the Middle East,
and whether the recent experience of a single huge shock leads
us to expect shocks of equal magnitude in the future. Can global
tsunamis on an equivalent scale be originated by other causes like
resource exhaustion, military conflict or climate change without
simultaneously destroying the integrative trend that now couples
economies and regions together? If so, then we may all be subjected
to an increasingly volatile economic environment. But if the true
alternative is not really an ‘averaging out’ of many independent
disturbances, but rather a re-fragmentation of the world economy
 Financial Decoupling of Emerging Asset Markets from Japan and US •2 0 3

in which the growth incentives of integration are surrendered and

new barriers are created to protect against future tsunamis, then
the cure for such turbulence may prove more costly in the long run
than the discomfort it causes.

Y
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Notes
1. In rankings based on Purchasing Power Parity, India should also be
included among the largest five.
2. As many authorities like Haggard (2000) have noted, global finan-
cial markets played a role in precipitating the crisis by first infusing
short-term capital into the region and then abruptly withdrawing it.
However, the case was not specifically one transmitted to Asia from
the United States or any other region; indeed stable US demand even-
tually proved useful in constraining and resolving the crisis.
3. Index abbreviations: ST = Straits Times (Singapore), GSP = Stand-
ard & Poors 500 (US), NIK = Nikkei (Japan), AO = All Ordinaries
(Australia), HIS = Hang Seng (Hong Kong), KS = Korea Stock Ex-
change, TW = Taiwan Weighted (Taiwan), SSE = Shanghai Stock Ex-
change, BSE = Bombay Stock Exchange (India), KL = Kuala Lumpur
(Malaysia).
4. Kim and Lee (2008) suggest using the Asian financial crisis of 1997
and 1998 as a temporal breakpoint because ‘After the 1997–1998 fi-
nancial crisis, East Asian economies took various steps toward eco-
nomic integration’. Likewise a break in 1998 would have corresponded
to a more equal division of the present data set between the ‘early’ and
the ‘late’ periods. In favour of breaking the sample at the turn of the
century are two practical considerations. First, the data for the Shang-
hai Composite series become available at this point. Second, Waelti
(2009) suggests that ‘business cycles are more synchronized during
recessions than during normal times’. Placing the decline phase in the
earlier period and the subsequent recovery in the later period might
therefore risk increasing the apparent degree of coupling in the former
and reducing it in the latter. The turn of the century occurred in be-
tween the Asian Crisis and the recession that followed the collapse
of the Internet bubble, so its virtue as a breakpoint is that it places
both the decline and the recovery phase of both crises wholly in their
respective periods. For the present downturn, data on the recovery
phase is not yet available; the second-best solution employed in the
Table 8.3 studies is to divide the later period into three sub-periods, so
as to confine the effects of the tsunami to period 3 only.
 204•Peter J. Morton

5. Daily closing prices for the major index values and exchange rates
were obtained from the sources noted beneath Table 8.2, and in ad-
dition daily closing values of the Morgan Stanley Far East Stock In-
dex were obtained from the Taiwan Ministry of Education Computing
Center for the period 1 January 1990 to 17 September 2010.
6. Interestingly, Rockinger and Urga (2001) observe a similar pattern of
negative correlations between Russia’s stock market index and those
Downloaded by [University of Toronto] at 13:44 15 January 2017

of the United States and Germany during the period 1994–97.

7. Volz (2009), writing in the Far Eastern Economic Review stresses
that Asia’s ongoing use of the US dollar as its main vehicle for the
accumulation of foreign reserves has preserved its synchronisation
with US business cycles even as other measures of US dominance
have declined. This point seems obvious enough to pass without chal-
lenge, but for the fact that Japan’s synchronisation with the same
set of countries has enjoyed a similar persistence even without this
advantage.
8. Kose et al. (2008) offer evidence that the truly global component of
the international business cycle has actually declined sharply during
the so-called period of globalisation, which they date from 1985. This
fact has been compensated for, apparently, by increased synchroni-
sation of cyclical components associated with country groups. The
implications for regional integration are limited because the authors
divide their sample into functional groups consisting of industrial-
ised countries, emerging countries, and ‘other developing economies’.
Regional groupings are not considered, however, the authors’ find-
ings with respect to the global synchronisation component may prove
generally applicable in light of recent increased political emphasis on
regional integration via NAFTA, ASEAN, Europe, at the expense of
full multilateral integration via GATT and WTO.

References
Adler, M. and B. Dumas. 1983. ‘International Portfolio Choice and
Corporation Finance: A Synthesis’, The Journal of Finance, 38(3): 925–98.
Cuthbertson, K. and D. Nitzsche. 2004. Quantitative Financial Economics,
2nd Ed. Chichester: John Wiley & Sons.
Dooley, M. and M. Hutchison. 2009. ‘Transmission of the U.S. Subprime Crisis
to Emerging Markets: Evidence on the Decoupling-recoupling Hypothesis’,
Journal of International Money and Finance, 28(8): 1331–349.
Haggard, S. 2000. The Political Economy of the Asian Financial Crisis,
Washington D.C.: Institute for International Economics.
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Hooy, C. W. and K. P. Lim. 2010. ‘Is Greater Level of Market Integration

Associated with Improved Market Efficiency?’ presented at the 12th
International Convention of the East Asia Economic Association, Ewha
Women’s University, Seoul, 2–3 October.
International Monetary Fund, Direction of Trade Statistics (DOTS). 1988–
2009. Geneva.
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Kawai, M. 2005. ‘East Asian Economic Regionalism: Progress and

Challenges’, Journal of Asian Economics, 16(1): 29–55.
Kim, Souyong and Jong-Wha Lee. 2008. ‘Real and Financial Integration
in East Asia’, Asian Development Bank, Working Papers on Regional
Economic Integration #17, June.
Kim, S., J. W. Lee and C. Y. Park. 2011. ‘Emerging Asia: Decoupling or
Recoupling?’ The World Economy , 34(1): 23–53.
Kose, M. A., C. Otrok and E. Prasad. 2008. ‘Global Business Cycles:
Convergence or Decoupling?’ Forschungsinstitut Zur Zukunft der Arbeit,
IZA Discussion Paper No. 3442, April.
Kumakura, M. 2006. ‘Trade and Business Cycle Co-movements in Asia-
Pacific’, Journal of Asian Economics, 17(4): 622–45.
Petri, P. 2006. ‘Is East Asia Becoming More Interdependent?’, Journal of
Asian Economics, 17(3): 381–94.
Pukthuantong, K. and R. Roll. 2009. ‘Global Market Integration: An
Alternative Measure and its Application’, Journal of Financial Economics,
94(3): 214–32.
Rockinger, M. and G. Urga. 2001. ‘A Time-Varying Parameter Model to
Test for Predictability and Integration in the Stock Markets of Traditional
Economies’, Journal of Business and Economic Statistics, 19(1): 73–84.
Volz, U. 2009. ‘Decoupling 2.0?’ Far Eastern Economic Review, 16 Septem-
ber, available at [Link] (accessed 20
January 2011).
Waelti, S. 2009. ‘The Myth of Decoupling’, Swiss National Bank, Zurich,
February.
 206•Peter J. Morton

Appendix
Results of Unit Root Testing of Monthly and
Daily Index Returns
Both the monthly and daily data series were composed of
log differences in the named index closing values for the stated
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period. To determine that they were stationary, a model of the

following form was fitted for each series:
Xt  Xt1  a  b(Xt1) 
With the following results for the monthly series:
Index Constant Lagged Coef Std. Error Durbin
(a) (b)
ST 0.40 0.88 0.06 2.02
SP 0.47 0.93 0.06 1.97
NK 0.31 0.98 0.06 1.99
AO 0.46 0.74 0.06 2.11
HS 0.78 0.93 0.06 2.00
KS 0.43 0.81 0.07 2.00
TW 0.06 0.85 0.08 2.04
SS 0.50 0.93 0.09 2.04
BS 0.78 0.85 0.08 2.02
KL 0.09 0.81 0.07 2.05

And for the daily series:

Index Constant Lagged Coef. Std. Error Durbin
(D) (E )
ST 0.01 0.89 0.01 1.998
SP 0.02 1.06 0.02 1.991
NK 0.01 1.05 0.02 1.976
FE 0.10 0.90 0.01 1.988
Stationarity is confirmed in all instances by rejection of Ho:   0.
Downloaded by [University of Toronto] at 13:44 15 January 2017

Section II

Trade in Services
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 9
India’s Trade in Services with Select FTA and
Non-FTA Partners:
An Analysis of Comparative Advantage
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Nabeel A. Mancheri

T
here has been a growing body of literature that examines
effects of free trade agreements (FTAs) on domestic and
world economy. The post-war debate started with Jacob
Viner’s seminal work on free trade agreements, in his famous 1950
book. In one of the classic demonstrations of the theory of the
second best, Jacob Viner (1950) showed that a move to free trade
between two countries that maintained their respective external
tariffs towards the rest of the world could leave them worse off.
The core arguments for free trade are as compelling today as they
were when Adam Smith set them out over two centuries ago. The
rich documented literature on FTAs can be broadly divided into
two aspects. The profound view comes from those who disagree
on this kind of arrangement, basically supporting the WTO-
led multilateralism. The second group predicts the increasing
welfare gains for the countries involved later leading to broader
liberalisation of all countries. The subject of free trade areas
remains controversial even among pro-free trade economists.
The controversy remained latent for nearly two decades
and came back with a vengeance in recent years with the advent
of ‘new’ or ‘second’ regionalism. Whereas the Vinerian analysis
of preferential trade agreements (PTAs) in the first regionalism
reflected ‘static’ questions concerning the welfare effects of unions
with defined membership, the second regionalism has been
preoccupied with what Bhagwati (1993) has described as the
‘dynamic’ time-path question, that is, in broad terms, whether PTAs
can provide an impetus to, or whether they will detract from, the
worldwide non-discriminatory freeing of trade. In other words, in
the phrasing and conceptualisation of Bhagwati (1991), will PTAs
be ‘stumbling blocks’ or ‘building blocks’ in the freeing of trade
multilaterally?
 210 •Nabeel A. Mancheri

One question which can legitimately be asked, therefore,

is whether preferential trading arrangements are more likely to
be conducive towards free trade or are likely to result in making
further trade liberalisation more difficult. The main thrust of
Panagariya’s (2002) argument is that all PTAs have serious
shortcomings. He considers that it is more important than ever to
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successfully complete the Doha Round of negotiations and bring

down the trade barriers in developed and developing countries on
a non-discriminatory basis.
The advocates of regionalism take opposite views on each
of these issues (Bergsten, 1996a and 1996b). They argue that
regional arrangements promote freer trade and multilateralism
and contribute to both internal and international dynamics that
enhance rather than reduce the prospects for global liberalisation.
Nordstrom (1995) finds that regional trade agreements might
provide trading blocs with stronger incentives to pursue multilateral
trade liberalisation and Perroni and Whalley (1994) indicate that
regional trade agreements generally take the form of free trade
associations (FTAs) in which member countries can choose their
external tariff rates freely.
There are two basic approaches to the empirical assessment
of FTAs. The first, known as the ‘gravity model’ approach, uses
a cross-section of bilateral trade data and attempts to estimate a
‘normal’ trade pattern. For situations where analysis prior to the
fact is required, the most commonly used technique in recent
years has been simulation with a computable general equilibrium
(CGE) model. The CGE models used have varied somewhat in their
underlying economic structure, behaviour of agents and focus, but
while the theoretical structure varies, commonly these models
build on the Global Trade Analysis Project (GTAP) database.
The simulation approach uses a static CGE model or a
dynamic intertemporal general equilibrium model.1 Robinson and
Thierfelder (1999) suggest that empirical evidence of proliferating
FTAs strongly supports the positive welfare effect of FTAs. Shahid
Ahmed (2010) investigates the potential economic impacts of a
prospective India–Japan FTA in goods with partial equilibrium
using the SMART model and computable general equilibrium using
the GTAP model. The study shows that both India and Japan’s
consumer’s surplus will be increasing as a result of the FTA.
 An Analysis of Comparative Advantage •2 1 1

Under such a scenario, the present chapter explores India’s

trade in services with four of her major trading partners, namely
US, Japan, Australia, and Singapore. Among them, two countries
are chosen where India has signed an FTA or is in the process of
signing a comprehensive agreement. This chapter focusses on the
features of trade in services of India, and the importance of services
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in bilateral trade of India with these FTA and non-FTA partners.

The study tries to analyse the impact of FTAs on the service
trade of India vis-à-vis non-FTA partners. The study subsequently
analyses technical barriers to service trade and other restrictions
imposed by India on the service sector and also looks into the
comparative advantages of services in India’s foreign trade. No
other study has ever used the data on services trade exclusively to
analyse the effects of an FTA on trade in services comparing it with
non-FTA trade partners. The chapter explores an understanding
of the current status of ‘revealed comparative advantage’ indices
(RCAs) among the services traded between these countries in
order to understand whether the countries have complementary or
competitive export structures.2
Among the four selected trading partners, India has
recently signed a Comprehensive Economic Partnership Agree-
ment (CEPA) with Japan and had an operational CEPA only with
Singapore which is quite comprehensive in its coverage in accord-
ance with Article V of the General Agreement on Trade in Serv-
ices, including promotion of mutual recognition of professions.
The services chapter in the CECA ensures that suppliers from India
are guaranteed access into the Singapore markets. This was a big
improvement since Singapore’s WTO-GATS commitment is rather
weak. Furthermore, both countries agreed to not restrict access
into their services markets by imposing quantitative restrictions.
One of the significant sections is the inclusion of a Mutual Recog-
nition Arrangement (MRA) by Singapore and India as part of the
Singapore–India CECA. The MRA allows Indian-trained auditors,
architects, accountants, doctors, and nurses to practice in Singa-
pore, and vice versa.
India–US trade in services is largely guided by their com-
mitments to WTO and is on a most favoured nation basis. They
have set up a number of sector-specific forums to facilitate trade
and investment. Prominent among them are the United States–
India Trade Policy Forum established in 2005 and the CEO Forum.
 212 •Nabeel A. Mancheri

Under the ‘Framework for Cooperation on Trade and Investment, of

2009’, the United States and India intend to meet the objectives of
developing and enforcing trade policies and fostering a trade. The
Economic and Financial Partnership launched in 2010 is laying the
groundwork for greater access to the capital markets and increased
public–private partnership in infrastructure, enabling greater par-
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ticipation by American businesses in closing India’s infrastructure

gap. The economic cooperation now covers energy, agriculture,
information and communication technology, and aviation safety
and security.
Australia and India agreed in April 2008 to undertake
a feasibility study for a possible bilateral free trade agreement to
explore the scope for building an even stronger economic and trade
relationship. In 2010 the report of the joint study group (JSG) has
been released. The report supports services liberalisation and seeks
to remove barriers that impose additional costs on exporters and
erode competitiveness. The possible FTA between India and Australia
would be expected to have substantial services sector coverage.
After 14 round meetings of the Joint Task Force to develop
an Economic Partnership Agreement (EPA)/CEPA between the
Republic of India and Japan, both countries signed an agreement
in mid-February 2011 and the agreement came into force by 1
April 2011. As part of the agreement India also stands to benefit
in services and both countries would soon be establishing a social-
security agreement, specifically for Indian qualified nurses and
Japanese certified careworkers. Under the CEPA, Japan has also
agreed to provide liberalised access for Indian professionals and
service providers such as chefs, nurses, English language teachers,
accountants, advertisers, and tourist guides. Both countries would
be creating a sub-committee that would explore the feasibility of
an MRA and the document put forward that

the Parties shall encourage that their respective professional

bodies in any regulated service sector negotiate and conclude,
within 12 months, any arrangement for mutual recognition of
education or experience obtained, requirements met, or licences
or certifications granted in that service sector, with a view to the
achievement of early outcomes (MOFA, 2001: 68).

In many of the recent agreements or in their frameworks

involving India, progressive liberalisation of trade in services
 An Analysis of Comparative Advantage •2 1 3

on a preferential basis with substantial sectoral coverage has

been adopted. For example, access to a wider range of banking
and insurance services. Any future FTA of India on services is
expected to take an ambitious approach, aiming for commercially
meaningful ‘GATS-plus’ outcomes. A decision would need to be
taken on whether to adopt a ‘negative’ or ‘positive’ list approach.
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In all its completed FTAs (with Singapore and South Korea) and
ongoing negotiations India has followed a positive list approach
which corresponds to the approach taken in services negotiations
at the WTO under GATS, while Australia has followed a negative
list approach in some recent FTAs (such as with Singapore, the US
and Chile). Each of these approaches has its merits.

India’s Status in Global Service Trade

India’s recent growth has been led by the dynamism of its serv-
ices sector — particularly, high-end, knowledge-intensive services
exports. Services occupy some 60 per cent of India’s GDP, based on
the WTO definition of services which includes construction. After
the restructuring of the Indian economy in the early 1990s, the
industry and services have continued to grow steadily. The indus-
trial sector expanded rapidly. The sector revived in 2002–3 and its
growth rate accelerated to 7.4 per cent in 2003–4 and to over 9
per cent in the next two years. The significant change was in the
services sector. The services sector grew at an average rate of 9 per
cent in the last two decades contributing nearly 60 per cent of the
overall growth of the economy. It continues to maintain impressive
growth and has recorded, in the last three years, a growth rate of
9.6 per cent, 9.8 per cent and 11.2 per cent respectively.
What emerges from these trends is that the services sector
has grown in importance as compared to other sectors in terms
of its contribution to GDP and also its growth rates since 1990s.
But this growth in share of GDP differs for different services.
Knowledge-based industries have been prominent among the
fastest growing services. The rapid expansion of the export-
oriented IT–ITES sector is much lauded, but several other key
services are also growing strongly, including telecommunications,
financial services, consulting services, private healthcare, and
biotechnology services.
 214 •Nabeel A. Mancheri

The import basket analysis of the $3.14 trillion world

imports of services in 2009 shows the major demanders of services
and the major types of services in demand. The top five importers
in world commercial services in 2009 as per WTO data were the US
(10.5 per cent), Germany (8.1 per cent), UK (5.1 per cent), China
(5.0 per cent), Japan (4.7 per cent), and India, which moved from
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the 15th position in 2004 to 10th position in 2005, and was in the
12th position in 2009 with 2.5 per cent share. India was the ninth
largest exporter of services with a share of 2.7 per cent in 2008 and
moved to the 12th position with a share of 2.5 per cent in 2009
largely due to the global financial crisis. The growth rate of India’s
imports of services at 40 per cent in 2007 was the highest among
the top 30 importers with Luxembourg at second place with 23 per
cent (WTO, 2010).
With the liberalisation of services, the sector has also
grown in its contribution to overall imports in segments such as
financial, insurance and travel and transport services. As a result,
the share of services in India’s total trade has grown from only
7 per cent in 1999–2000 to around 36 per cent in 2007–8. This
growth has been driven by the miscellaneous services segment,
especially IT and ITES and other business services. Greater progress
has been made in reforming services than in other sectors of the
economy. Trade, hotels, transport, and communication services
grew at double digit rates for the three consecutive years 2005–8.
During the same period, exports of services increased by 27.4 per
cent, mainly due to increased software services exports; imports of
services increased by 24.2 per cent.
In the case of India, there has been a strong and consistent
structural shift in services exports away from traditional areas like
travel and transport services and towards other services, mainly
business services such as information technology, business process
outsourcing, and various professional services. India’s services exports
have grown from US$ 11.1 billion in 1998 to US$ 52 billion in 2005
and US$ 87 billion in 2007 to US$ 102.9 billion in 2008, at an average
annual rate of 25 per cent during the 1995–2008 period and is nearing
merchandise exports at $145.3 billion, growing more rapidly than
the services output, indicating the strong outward orientation of this
sector. If labour services (reflected in private transfers) are seen, then
the contribution of services will be still higher. Latest data (2007–8)
of export of services for India available mainly by broad categories
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Table: 9.1: India’s Total Trade in Services by Services Category (in Million US$)

2005 2006 2007 2008

Exp Imp Exp Imp Exp Imp Exp Imp
Total Services 52527.3 32548.5 69730.1 40324 86965.3 47592.4 102949 56554
Transportation 5754.08 7413.36 7561.01 8321.18 9035.32 10118.7 11317.8 13667.3
Travel 7492.85 6186.63 8633.89 6844.96 10729 8219.17 11831.9 9602.49
Communication 1565.92 418.01 2181.08 606.07 2347.93 862.91 2422.9 1003.82
Construction 345.78 602.01 618.94 793.99 753.2 727.99 721.94 755.01
Insurance 941.08 856.24 1113.18 834.01 1506.7 887.13 1548.16 1117.34
Finance 1143.02 869.03 2356.97 1949.9 3378.96 3236.94 4058.95 3552.01
Computer and Informa- 21874.9 1265.85 29088.1 1956.94 37491.2 3472.81 49378.9 3418.88
tion
Royalties and License Fees 205.98 671.83 60.91 845.95 163.13 1159.82 147.82 1577.87
Other Business 12764.4 13693.8 17535.5 17593.4 20733.6 18319.5 20426.4 21062.3
Personal, Cultural and 111.08 104.9 306.47 103.92 508.93 168.91 707.19 295.99
Recreational Services
Government Services 328.15 466.89 274.01 473.61 317.37 418.47 386.8 500.96
Source: Extracted from OECD. 2010. ‘Trade in Services by Category of Service’, OECD Statistics on International Trade in Services (database), available at
[Link] (accessed 12 December 2010).
An Analysis of Comparative Advantage •2 1 5
 216 •Nabeel A. Mancheri

shows the high growth of other business services (including software

services and business services) which grew by 70.5 per cent in 2006
and further by 47.6 per cent in 2007 and 35.9 per cent in 2008. Travel
services exports grew by 20 per cent and transportation by 28 per cent
in 2008.
In contrast to merchandise trade India has a clear
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advantage in the service sector, where it has a considerable trade

surplus. The Indian case clearly shows the impact of inherent
and acquired sources of competitive advantage coupled with
favourable external developments and market conditions on the
country’s services trade and the critical role that has been played
by the service sector in facilitating the country’s integration with
world markets.

Bilateral Trade in Services between

India and Selected Partners
Analysis of trade in services is still restricted by the lack of data,
despite statistical improvements. This section describes the
bilateral service trade flows among India, US, Japan, Singapore,
and Australia. Country-wise exports or imports of services of India
are not published now by RBI or any other statistical agency in
India. Some rough indication of country-wise exports of India can
be seen from the mirror data of other countries. Most of the data
for this chapter are obtained from the OECD database on services,
and WTO trade profiles.
Analysis of bilateral trade in services shows that Singapore’s
service exports to India grew from a level of US$ 1.6 billion in 2002
to US$ 4.07 billion in 2008, while bilateral imports grew from
US$ 799 million in 2002 to US$ 2.18 billion in 2008. Singapore’s
exports of commercial services to India have grown at a faster rate
than that to the rest of the world. The growth rate of both exports
and imports was considerably higher in post-FTA years compared
to previous years. The growth rate of Singapore’s exports to India
for 2004–8 was 47.5 per cent compared to 24 per cent for 2002–4.
In fact, in 2008, Singapore’s trade in commercial services to the rest
of the world started to decline while the bilateral trade with India
continued at a healthy 24 per cent (estimated average trend). The
four largest categories of bilateral commercial services trade were
 An Analysis of Comparative Advantage •2 1 7

Table 9.2: India’s Service Trade with US, Japan, Singapore and Australia
(in million US $)

Exports
2000 2002 2004 2006 2008
Imports
2588 3294 4521 6740 10632
USA
1911 1827 2887 7739 12164
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332.2 329.3 574.8 760.1 1604.1

Japan
418.5 322.9 358.6 411.0 757.5
857.8 1617.0 2139.4 2879.0 4078.5
Singapore
397.5 799.0 1046.7 1556.4 2189.5
273.0 261.8 613.3 1155.8 2489.5
Australia
122.9 112.4 192.6 287.6 519.2
Source: OECD. 2010. ‘Trade in Services by Category of Service’, OECD Statistics on International
Trade in Services (database), available at [Link]
(accessed 12 December 2010).

transportation, trade-related and travel services, communication

and other services, and financial services (including insurance). It
is also important to note that in all these sub-sectors, Singapore’s
exports have grown at significantly stronger rates than its imports
from India.
A detailed analysis of the available trade data (by breaking
up the data series into pre-CECA and post-CECA groups with
2005 as the point of inflection), however, indicates that after
the CECA was implemented, the trend in the rates of growth of
bilateral trade moderated significantly compared to the growth
in bilateral commercial services trade in the five years preceding
the CECA implementation. This is a clear indication that despite
the potential, bilateral trade in commercial services has failed to
take advantage of the preferences and concessions garnered in the
CECA negotiations (Karmakar, 2009).
Though US is not an FTA partner of India, US services
exports to India more than tripled over the past several years,
increasing from $2.5 billion in 2000 to more than $10.6 billion
in 2008. The rapid growth in these exports has been supported
by increased FDI from India to the United States and the growing
merchandise trade relationship between the two countries. United
States service imports from India also grew very rapidly throughout
the last decade, increasing from 1.9 billion in 2000 to 12.16
billion in 2008, making the US India’s largest trading partner and
 218 •Nabeel A. Mancheri

export market in the service sector. In 2008, the largest US service

export category to India was the travel sector at $3 billion. Other
major categories included education services ($2.7 billion) and
business, professional and technical services ($1.1 billion). Indian
students are now the largest group of foreign students within the
United States and represent a major growth market for American
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institutions of education.
India is not a considerable trade partner in the services of
Japan. In the case of Japan’s imports of total services, India’s share
is only 0.2 per cent, while China’s share is 4.3 per cent and all South
East Asian countries have much higher shares than India (BoP Data,
Japan, MOFA, 2009). This clearly shows that India has not made
any impact in the Japanese market in services. In this context, an
Economic Partnership Agreement (EPA) is essential as an institu-
tional infrastructure to further accelerate and consolidate these
business activities. In services, the major hurdle lies in the area of
mutual recognition agreements (MRAs) wherein both parties accept
foreign professionals with degrees and diplomas offered in their
home country. Also, a 15 per cent withholding tax — the share of the
payment withheld by the paying party on account of taxes — levied
by Japanese authorities is also a major hurdle discouraging Indian
professionals from working in Japan, and needs to be sorted out.
Table 9.2 reveals that India’s bilateral trade in services
with Japan and Australia is growing. In particular, the service
imports outgrow the service exports both in the case of Japan and
Australia. India has a service trade deficit with both countries and
the gap between exports and imports has widened over the years.
India’s exports to Japan were equal to US$ 419 million in 2000
and declined to US$ 300 million in 2003. In 2005 they rose to US$
341 and further expanded to US$ 411 in 2006 to the level of what
they were in 2000. In 2008 India exported US$ 757 million worth
of services to Japan. However, the imports of services have been
growing over the years. The imports from Japan grew from US$
332 million in 2000 to US$ 760 million in 2006 and advanced to
US$ 1.6 billion in 2008. The balance of payment statistics of the
Ministry of Finance, Japan show that its service trade balance with
India has grown from a deficit of minus 9,300 million yen in 2000
to 87,500 million yen in 2008.
The table also illustrates that services exports to India from
Australia have grown rapidly, from US$ 273 million in 2000 to US$
 An Analysis of Comparative Advantage •2 1 9

2.4 billion in 2008. Australia’s dominant services exports to India

in 2008 were education-related travel services (US$ 2.8 billion), a
reflection of the number of Indian students studying in Australia.
India exports a range of services to Australia, including ITES,
software. The balance of services trade is in Australia’s favour. With
a 23.2 per cent trend growth rate over the past five years, India
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has been Australia’s fastest-growing services export market after

China, in large part reflecting the strength of education exports
— a direct spin-off from India’s rapid growth. Exports increased
by 36 per cent in 2005–7, pushing India up into ninth place as a
services export market for Australia. Table 9.2 shows that India’s
service exports to Australia moved modestly upwards from US$
123 million in 2000 to US$ 519 million in 2008.
The Australian Bureau of Statistics (ABS) estimates imports
of computer and information services and other business services
from India to be worth around $ 80 million in 2008 ($ 35 million
in 2002–3). The Indian data on exports to Australia of computer
services (excluding exports of companies engaged exclusively in
business process outsourcing activities) are higher, perhaps owing
to the fact that they include revenues derived by the Australian
subsidiaries of Indian companies.
Despite high levels of publicity for the relocation of
corporate functions to India by some major companies, the balance
of bilateral services trade is firmly in Australia’s favour. While
Australian direct investment in India’s services sector is presently
at modest levels, it is set to increase with some recent investment
decisions and the conclusion of contracts. Indian companies have
made substantial investments in Australia’s services sector, most
notably in IT. There is no doubt that India’s current boom sectors
offer opportunities for Australian participation. Australia is itself an
attractive international business process outsourcing destination
(A. T. Kearney, 2005) because of its experienced, English-speaking
and educated workforce and stable business environment (ibid.).

Revealed Comparative Advantage Indices in

Services of India and Selected Trade Partners
This section provides a comparative analysis of the Revealed Com-
parative Advantage (RCA) index for India, US, Japan, Singapore,
 220 •Nabeel A. Mancheri

and Australia for the years 2000 to 2008. The most common RCA
index was developed by Balassa (1965).
RCA = (Eij / Eit) / (Enj / Ent)
The indices of a service are defined as the ratio of exports
of a ‘service’ category to a country’s total service exports, divided
by the ratio of world exports of this ‘service’ to total world service
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exports. The value of this index may range from zero to a very
large number. If the index is greater than 1 this implies that the
country is relatively specialised in the service concerned and has a
comparative advantage in such exports compared with the world
average. A value less than 1 indicates a comparative disadvantage.
An RCA index is in many ways a crude measure of comparative
advantage. For example, it does not take into consideration the
presence of trade barriers, and, since it is based on BoP data, it does
not give any indication of a country’s comparative advantage in
supplying services through commercial presence or the movement
of individual service suppliers.

Table 9.3: Revealed Comparative Advantage Indices in

Services for Selected Countries

2000 2002 2004 2006 2008

India 1.13 1.47 1.88 1.94 2.08
USA 1.89 1.64 1.75 2.11 2.27
Japan 0.85 0.76 0.83 0.97 0.99
Singapore 1.21 1.57 1.81 2.13 2.19
Australia 1.02 1.35 1.50 1.74 1.91
Source: Author’s calculation based on data from IMF. 2010. Balance of Payment Statistics,
online database, available at [Link]
170784 (accessed 22 December 2010).

Table 9.3 reveals that the RCA indices for India, US and
Singapore are relatively higher and have grown over the years. An
index value greater than 1 implies the country is relatively specialised
in the service concerned and has a comparative advantage in such
exports compared with the world average. The index for Australia
which is above 1 reveals the comparative advantage of Australian
services sectors but is not as intense as India, US and Singapore.
This higher index must be attributed to the positive contribution
 An Analysis of Comparative Advantage •2 2 1

of education, travel, tourism, and to a great extent the financial

services of Australia to the services sector. Whereas in the case of
India the higher index shows India’s comparative advantage in the
services trade in sectors like computer and information technology,
and relative importance of telecom, commercial and other business
services, the index for Japan shows a different picture with a
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value below 1, though it has grown from 0.85 in 2000 to 0.99 in

2008. In services, Japan’s comparative advantage is considerably
lower than in manufacturing. Though Japanese companies are
prominent in the international financial market and related service
trade, their share is not significant as compared to other sectors of
the Japanese economy.
The services sector of India presents a different picture.
A process of export reorientation is clearly underway and a
significant shift has taken place towards more advanced, in some
cases high-skill intensive, services. Moreover, new services, such
as computer and selected professional services, have emerged
in India’s exports to a greater extent than in other countries.
The most spectacular evolution was recorded by computer and
information services whose share in India’s services exports
almost doubled between 2000 and 2008 to reach almost half of
India’s services exports.
Figure 9.1 shows India’s RCA indices for major service
categories from 1990 to 2006. The major category that India
has a higher RCA index is other commercial services, which also
contribute to the largest share of India’s service exports basket.
In broad sense the commercial services include computer and
information services, telecom, business, and financial services.
The figure shows that the index for transportation and travel
has declined. The high index for commercial services is related
to the rapid growth exports of commercial services and both
software and non-software exports of computer services.
Within computer services, India has moved from providing only
low-end back office services (data entry, etc.) to more integrated
and higher-end service bundles in fields such as customer care,
human resource management and product development. In
addition, the analysis points to an increase in India’s relative
competitiveness as reflected by the revealed comparative
indices.
 222 •Nabeel A. Mancheri

Figure 9.1: Evolution of India’s Sectoral RCAs

1.8
1.6
1.4
1.2
RCA index

1
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0.8
0.6
0.4
0.2
0

00
98
92

02
90

96

06
94

04
20
19
19

20
19

19

20
19

20
Year
Transportation Travel Other commercial
services

Source: Chanda, R. 2008. ‘Services Trade and Investment Liberalisation, and Domestic
Regulation — A Summary of Six Country Case Studies’, prepared for Consumer Unity Trust
Society, CUTS International, Monograph, 2/2008.

Relative Degree of Trade Intensity

The Relative Degree of Trade Intensity (RDTI) is a measure of country
i’s relative share of country j’s import market or vice versa. For
example, in the case of India, it implicitly benchmarks India’s trade
performance in US, Japan, Singapore, and Australia against those
of India’s trade competitors. The bilateral export/import intensity
index is found by adjusting a country’s export ratio by means of
the relative importance of its exports to the total imports of another
country. The index was first used by Kojima (1964) and Drysdale
and Garnaut (1982). To investigate the bilateral trade intensity
between these three countries, this study uses three different proxies
for bilateral trade intensity, following Frankel and Rose (1998): Wxt,
Wmt and Wtt. The first uses export data only, the second, data for
imports, and the third, both export and import data:3
Xijt
Wxt (ij)  _______
Xit  Xjt
 An Analysis of Comparative Advantage •2 2 3

Mijt
Wmt (ij)  _______
mit  Mjt
Xijt  Mijt
Wtt (ij)  _________________
Xit  Mit  Xjt  Mjt
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Table 9.4: Services Trade Intensity Indices between India and the Selected
Trading Partners

2000 2002 2004 2006 2008

USA 0.77 0.67 0.70 0.75 1.27
Japan 0.32 0.25 0.22 0.43 0.53
Singapore 0.77 0.87 0.80 0.96 1.13
Australia 0.66 0.57 0.56 0.93 0.98
Source: Author’s calculation based on OECD database on trade in services in OECD. 2010.
‘Trade in Services by Category of Service’, OECD Statistics on International Trade in Services
(database), available at [Link] (accessed 12
December 2010).

With all selected economies, India’s trade intensity is

less than what might be expected given the importance of these
four countries’ share in total world trade. Except for the US and
the Singapore (where the index is more than or approaching 1),
India’s trade with all four countries should be much greater. The
trade intensity index during the sample period features low and
sometimes decreasing values. These findings are further supported
by the low (in most cases insignificant) shares that India holds in
these country’s services exports and imports suggesting that there
is substantial scope for strengthening India’s trade in services with
these countries.

Intra-industry Trade Indices —

Selected Services Sectors of India
For measuring a country’s specialisation and comparative
advantage in trade, researchers usually apply the index of intra-
industry trade. One of the most commonly used indices to measure
 224 •Nabeel A. Mancheri

the intra-industry trade is the Grubel-Lloyd (GL) index. The GL

index is defined as:
GLij = 1ⴚ|(Xij  Mij) (Xij + Mij)|
where Xij are exports of a service i by country j and Mij are imports
of a service i by country j. A GL index that approaches 0 implies
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low levels of intra-industry trade while a GL index that approaches

1 suggests high levels of intra-industry trade.

Table 9.5: Intra-industry Trade Indices — Selected Services Sectors

2000 2002 2004 2006

Communication services 2.74 2.96 3.49 3.87
Computer and info services 15.2 20.09 19.9 21.03
Construction 2.55 0.30 0.97 0.83
Finance 0.42 0.46 0.51 0.65
Insurance 1.35 1.27 0.91 1.05
Other Business 1.79 0.91 0.74 0.97
Royalties and license fees 0.15 0.07 0.03 0.15
Transportation 0.86 0.85 0.98 0.17
Travel 1.10 0.98 0.94 1.07
Source: Author’s calculation based on IMF. 2010. Balance of Payment Statistics, online database,
available at [Link] (accessed
22 December 2010).

Travel, financial, insurance and communication services

feature high levels of intra-industry trade, indicating India’s
integration into the global service supply chain. Interestingly,
trade in computer services in India seems to be entirely an inter-
industry phenomenon. The services trade data reported so far refer
mainly to services traded internationally by the first and second
mode of supply. Only a limited extent of trade via the movement
of natural persons (part of computer and information services, of
other business services, and of personal, cultural and recreational
services) and via commercial presence (part of construction
services) was included. However, trade in services often takes
place in different ways compared to trade in goods and such data
usually ignore information on temporary movement of natural
persons (Mode 4) and commercial presence (Mode 3).
 An Analysis of Comparative Advantage •2 2 5

Trade Similarity Indices between India and

Selected Partners, 2001–2006
To complement the above analysis, this study measures the degree
of services trade similarity between India’s exports to and imports
from selected countries.4 The similarity index gives information
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about the potential for direct trade between countries by assessing

the degree of complementarity between the structure of exports
and imports of the analysed countries, without measuring the
extent to which the countries in reality take advantage of that
potential. This index is based on India’s total services exports to
all destinations and does not reflect (or use) actual bilateral trade.
It does, however, reflect the potential for bilateral trade flows
between pairs of countries.5

Table 9.6: Trade Similarity Indices between India and the

Selected Partners, 2001–2006

2001 2003 2006

USA 0.61 0.63 0.66
Japan 0.52 0.48 0.54
Singapore 0.53 0.50 0.51
Australia 0.43 0.42 0.47
Source: Author’s calculation based on IMF. 2010. Balance of Payment Statistics, online database,
available at [Link] (accessed
22 December 2010).

There are two noticeable results from Table 9.6. First,

India tends to have a moderate trade potential with all mentioned
countries though it varies slightly. India’s trade potential is
relatively higher with US. However, India’s trade potential with
most partner countries shows an increasing trend. The moderate
value also means that the structure of India’s service exports is not
adapting to the structure of its partners’ imports. Indeed, India’s
service exports have achieved marginal gains in market shares in
these countries. Only for Australia do more than 1 per cent of its
service imports originate from India. Contrary to goods, the analysis
of the composition of the services trade does reveal considerable
export diversification but some of the RCA indices of key growth
sectors such as insurance, construction or other business services
 226 •Nabeel A. Mancheri

are declining, raising concerns about the prospects for their future
development.

Barriers to Services Trade in India

Trade in services involves a less tangible exchange between
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producers and consumers and restrictions usually take the form of

government regulation. Much of the regulation by governments,
and its effect on the price of services, is often difficult to identify
and quantify. The structure of the GATS thus differs from the GATT,
for instance. This section provides an assessment of the existing
barriers to the services trade of India. Since it is yet not known how
far India is going to liberalise its service sector once it concludes
its bilateral agreement with Japan and Australia, this study looks
into some existing literature where the authors have identified
various restrictions that India has imposed upon the service sector
both under the GATS commitment and existing preferential trade
agreements.
Hoekman and Braga (1997) discuss some of the important
barriers to trade in services. In case of some services, trade is
prohibited while in others there are important restrictions imposed.6
A common feature is that domestic regulation in each service
field is one of the factors that prevents international transactions.
Domestic regulation is based not only on economic and technical
factors but also on political, cultural and national security factors.
India has made services commitments in the WTO Uruguay
Round. It made partial commitments in 42 subsectors — or about 23
per cent — across six of the 12 major services groupings (business,
communications, construction, financial, health, and tourism) in the
Service Sectoral Classification List. India made no commitments on
distribution, educational, environmental, recreational, transport, or
other services not included elsewhere. However, since the commitments
in the Uruguay Round at the WTO, India has autonomously opened
up its services sectors and this is reflected in its offer at the WTO
wherein it has offered 11 out of the 12 services sectors as per the
Services Sectoral classification of the WTO. The details are reflected
in India’s Revised Offer of 2005 at the WTO.
Starting from a low level of bindings in its existing GATS
schedule for these two modes (less than a quarter of sectors are
 An Analysis of Comparative Advantage •2 2 7

bound under Mode 3 and less than 10 per cent under Mode 1),
various new sectoral bindings were proposed in GATS offers.
GATS+ commitments in the PTA with Singapore essentially
take the form of improvements in relation to Mode 3 for sectors
already committed in the GATS schedule/offer. Many of these
improvements took the form of the removal of the requirement for
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foreign investors with prior collaboration in the sector to obtain

approval from the Foreign Investment Promotion Board. This
requirement, which was included in virtually all the sub-sectors
offered by India, has, except for construction and distribution, been
removed from the PTA. In addition, very specific improvements
are also made in financial services. On the other hand, it can be
noted that some commitments in the PTA are worse than the offer.
In telecommunications, for instance, the foreign equity limitation
for voice mail, online information and database retrieval, and
enhanced/value added services is 51 per cent, even though a higher
percentage had been offered in the Doha services negotiations
(WTO, 2006).
Various reports dealing with India’s services sector
highlight particular problems related to market access in financial,
telecommunication and distribution services. The OECD Secretariat
assessed barriers in banking, insurance, telecom (fixed and
mobile), and distribution service and liberalisation effects in many
countries, including India (OECD, 2007). By using alternative
weighting methods and improved econometric specifications
that include barriers affecting each mode of services supply and
additional sector-specific regulatory variables, this chapter draws
conclusions as to India’s trade restrictiveness compared with both
developing countries and the OECD. The results show that India
is quite restrictive in banking, insurance, mobile telecom, and
distribution. The sectoral analysis in Figure 9.2 describes the trade
restrictiveness index (TRI) in selected services sectors in India and
the underlying barriers.
The results show that despite significant liberalisation
steps, which in the analysed sectors far exceed India’s GATS
commitments, barriers remain high. The TRIs are well above the
OECD average and most of the selected emerging economies.
Moreover, most of these services sectors have for a long time
been in the public domain and they suffer not only from high
barriers to trade, but also from domestic constraints in terms of
 228 •Nabeel A. Mancheri

Figure 9.2: India’s Trade Restrictive Index for Banking, Insurance and Telecom

A. Banking B. Insurance
3.0 3.0

2.5 2.5
OECD average OECD average
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2.0 2.0

1.5 1.5

1.0 1.0

0.5 0.5

0.0 0.0
India Russia China Brazil India China Russia Brazil

A. Fixed telecom B. Mobile telecom

2.5 2.5

2.0 2.0
OECD average OECD average
1.5 1.5

1.0 1.0

0.5 0.5

0.0 0.0
India China Russia Brazil India China Russia Brazil
Source: OECD. 2009. ‘India’s Trade Integration, Realising the Potential’, OECD Trade
Policy Working Paper No. 88, Paris, PP 39-41, available at [Link]
dataoecd/34/60/[Link] (accessed 8 January 2011).

burdensome regulatory measures and state monopolies. These

services consequently suffer from inefficiencies and low growth.
The negative impact of restrictions on the performance of banking
and distribution services is presented in Figure 9.2.
Deregulation of the services sector has been one of the
highlights of the Indian reforms. Telecommunications has been
 An Analysis of Comparative Advantage •2 2 9

substantially opened up to competition. Newer sectors broadly

defined as Information Technology and IT Enabled Services are
largely open. Significant changes have occurred in the financial
sector although foreign investment in banking and insurance
remains relatively less open. Transport, power, business services
such as accountancy and legal services remain protected from
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foreign competition, as does the retail sector.

Conclusion
The service sector has emerged as the largest and fastest-growing
sector in the global economy in the last two decades, providing more
than 60 per cent of global output and, in many countries, an even
larger share of employment. The growth in services has also been
accompanied by the rising share of services in world transactions.
This study finds that, services, today, are the dominant sector of
economic activity for India. India’s recent growth has been led
by the dynamism of its services sector — particularly high-end,
knowledge-intensive services exports. The study finds that there
has been a structural shift in the composition of India’s services
exports, away from traditional services such as transport and
travel and towards miscellaneous services, in particular, software
services. It is found that the growth pattern in the service sector
has not been uniform across all services in India. The high growth
services have been mainly those that have undergone deregulation
and significant changes in policies concerning participation of
private domestic and foreign players.
This study suggests that India’s services exports seem
to have achieved higher rates of export diversification than
goods with computer and information services experiencing the
biggest increases. There is a shift in services exports towards more
advanced, in some cases high-skill intensive sectors, which is not
discernable in manufacturing exports. However, even in services,
India is losing market shares in a number of sectors (such as
other business services, royalties and insurance) indicating that
the success of computer services might not be so readily repeated
in other services. The structure of services imports has remained
considerably more stable. Other services (other business services,
communication and construction) as well as travel services seem
to be the most dynamic categories.
 230 •Nabeel A. Mancheri

The results of the statistical analysis such as relative

comparative advantage, trade complementarity index (TCI)
and relative trade intensity (RTI) show that each of the studied
countries have specialisation in different service sectors and
comparative advantage in particular sectors can be utilised to
enhance both merchandise as well as service trade. This gives
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a particular country a competitive edge in supplying the inputs

that are necessary for producing the service or commodities in
others’ markets. For example, India has developed a comparative
advantage in the supply of software services, because it is well-
endowed with skilled but comparatively cheap software engineers.
Similarly, Australia is increasingly competitive in the provision of
regional financial services because of its comparative advantage
in telecommunications and legal services and Japan too has
a competitive edge in financial, construction, transport, and
telecommunication services.
The history of commercial relations clearly demonstrates
what a powerful force complementarity is. Notwithstanding a wide
range of potential and actual barriers, trade in services between
India and selected trading partners has flourished, to the advan-
tage of all countries. One lesson we can draw from this success, and
from the limited nature of commercial ties that they have obvious
potential to become broader (such as in the services sector). The
basic principles of all countries are that the achievement of com-
prehensive liberalisation in trade in services is of benefit to every-
one by attracting further investment on the one hand and through
the results of their increased competitiveness, production capac-
ity, export, and employment opportunities on the other. Though
the service trade between India and these countries is much lower
compared to their other trade partners, the impressive growth rate
over the last few years gives hope for further expansion.

Notes
1. For example, Brown, et al. (1992) estimate that NAFTA has increased
intra-region trade by 8 per cent from the baseline, and has led to a
welfare gain of 0.1 per cent of GDP for the United States and 5 per
cent of GDP for Mexico. Scollay and Gilbert (2000) estimate that a
 An Analysis of Comparative Advantage •2 3 1

Japan–Korea–China FTA will generate welfare gains of 0.25 per cent

of GDP for Japan, 0.80 per cent of GDP for Korea, and 2.1 per cent
of GDP for China. Urata and Kiyota (2003) expect that an East Asian
FTA including China, Japan, Asian NIEs, and ASEAN will produce
welfare gains ranged from the lowest 0.19 per cent of GDP for Japan
to the highest 12.5 per cent of GDP for Thailand. McKibbin, et al.
(2004), show that gains for Korea and Japan from a bilateral FTA will
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amount to about 0.1–0.2 per cent of GDP per year for both countries.
2. The chapter also uses a number of economic tools (Relative Degree
of Trade Intensity, Relative Degree of Trade Complementarity, Intra
industry Trade Index, etc.) to map out the trade patterns, trade com-
plementarities and trade competitiveness.
3. The index reveals the bilateral trade intensity of international trade
between two countries, i and j, at a point in time t. Where Xijt denotes
total nominal exports from country i to country j during period t; Xit
denotes total global exports from country i; and M denotes imports.
An index number for the RDTI of 1.0 indicates country i is doing
relatively better than its trade competitors in the country j’s market;
an index number below 1.0 suggests country i’s trade competitors are
outperforming in country j’s market and when the figure is greater
than 1, it indicates that the two nations have a comparatively strong
export relationship. _____
4. The measure is defined as TSij = xin  yjn /  x2in  yjn2; where
n n n
xin represent exports of commodity i by country n and yjn represent
imports of commodity j by country n. The index varies between 0 (no
similarity or correspondence and consequently, no trade potential) and
1 (perfect similarity and significant trade potential). There is potential
for trade when (0<TSij<1), with trade possibilities increasing as the
value of TSij gets closer to 1. TS is an ordinal measure ranking items
within a given collection from highest to lowest without measuring
their magnitudes. To facilitate the analysis, the study will use the fol-
lowing standard rule of thumb: TS values of 0.8 to 1.00 indicate very
high similarity and significant trade potential, values of 0.6 to 0.8 in-
dicate high similarity and high but lower trade potential than in the
previous case, values between 0.4 and 0.6 indicate moderate similarity
and moderate trade potential, values between 0.2 and 0.4 indicate low
similarity and low trade potential, and values between 0.0 and 0.2 in-
dicate little if any similarity and no trade potential at all.
5. Results should be interpreted with care because as opposed to goods
trade where data is available at a high level of desegregation, services
data is available for a limited number of sectors/sub-sectors.
6. Roy Martin et al. (2007) assess PTA commitments on sector cover-
age and their analysis captures the breadth of commitments across
all services sectors, highlighting, for example, how many sectors
 232 •Nabeel A. Mancheri

have been left without any binding whatsoever. Sampson and Snape
(1985) and Stern and Hoekman (1988) classified barriers to services
trade on the basis of four modes of services.

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 10
Export Potential of India’s
Higher Education Sector:
Identifying Opportunities and Constraints
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Shahid Ahmed and Sushil Kumar

A
cademic mobility and education exchange across borders
has long been a central feature of higher education. In recent
decades, trade in education services has become a major
business in a number of countries. Australian export revenue from
higher education services was about $18.6 billion in 2009 while
United States’ receipts of export revenue from higher education
services reached $17.8 billion in 2008, with a positive trade
balance of about $12.6 billion. The top three countries of origin
of students, accounting for almost a quarter of all international
students, are all Asian. Chinese students alone account for around
students 15 per cent, Indian students account for 5 per cent and
Korean students for 4 per cent of the world’s mobile students.
India is the second largest importer of educational services.
Over US$ 13 billion is spent every year by about 450,000 Indian
students on higher education abroad as they are not accommodated
by domestic institutions (University World News, 2008). The primary
reason for a large number of Indian students seeking higher education
abroad is the lack of capacity in Indian institutions, better market
opportunities, social prestige, etc. Evidence on the true added value
of study abroad remains extremely scarce. However, this is generally
argued by generalised statements such as the following: ‘Study-
abroad programmes enjoy prestige mainly because they enhance one’s
academic credentials, offer better-paid employment opportunities and
provide entry to influential professional networks’, ‘the advantages
(employment and prestige) are higher in developing countries than in
developed countries’ (Varghese, 2008).
India also has the third largest higher education system in
the world (after China and the US) (UGC, 2010). Despite having
the third largest higher education system, India also has one of
the lowest public expenditures on higher education per student at
 236•Shahid Ahmed and Sushil Kumar

US$ 406, which compares unfavourably with Malaysia’s $11,790,

China’s $2,728, Brazil’s $3,986, Indonesia’s $666 and Philippines’
$625. This expenditure in the USA is $9,629, in the UK it is
$8,502 and in Japan $4,830. This might be affecting the quality of
education in India (Ministry of Commerce, 2006).
To the best of our knowledge, there is a dearth of research
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in India on the export potential of educational services. Thus, the

present study will add to the existing literature on these issues.
The specific objective of this study is to examine the export
potential of Indian higher education and to identify the factors
affecting the inflow of international students in India. This sector
has also been identified as one of the lucrative trade sectors in the
recently signed CECA/CEPA by India. The second section of the
chapter provides the review of selected literature. The third section
discusses higher education under GATS and India’s commitments.
The fourth section briefly discusses volume and composition of the
flow of services. The fifth section discusses research methodology
and databases. The sixth section reports and discusses the results
while the seventh section provides concluding remarks.

Review of Literature
GATS clearly identifies education as a service sector to be liber-
alised.1 Three common terms used to describe the international
nature of education are ‘internationalisation’, ‘cross-border educa-
tion’ and, more recently, ‘trade in education’. There is a hierarchy to
these terms, with ‘internationalisation of education’ being the most
comprehensive, ‘cross-border education’ being one component
of internationalisation and then ‘trade in education’ being used
to characterise some, but not all, cross-border activities (Knight,
2004). As far as the scope of this chapter is concerned, trade in
services implies mobility of international students.2
Mazzarol et al. (2001) explain the push and pull factors
responsible for the worldwide pattern of student mobility, namely,
(a) the level of economic development in the source country, (b) the
capacity of the source country’s domestic education system to meet
demand, (c) the per capita incomes, (d) the size of the employment
market for professionally educated graduates, (e) knowledge and
awareness of the study destination, (f) recommendations by rela-
tives and friends, (g) cost of study, (h) environment, geographical
 Export Potential of India’s Higher Education Sector •2 3 7

proximity of the home country to the destination country, and (i)

the presence of family and friends in the study destination. The first
four factors reflect push factors and the remaining are pull factors.
There are a number of empirical studies in economic
literature to verify the factors behind mobility of international
students. Mazzarol et al. (2001) conducted a study on Chinese
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students to identify the most important factor for choosing the

destination for higher education; they found that lower tuition fees
for education courses were a factor considered by 47 per cent of
respondents. This result was also supported by Back et al. (1997) for
foreign students in Australia, New Zealand, the United Kingdom,
Canada, and the United States of America. They showed that the
cost of study is a major factor that foreign students consider when
making a decision to study in other countries.
Mazzarol’s (1998) results also showed that the standard
of higher education institutes affects the attitudes of international
students when they select an institution for their study to other
countries. This was supported by studies by Eduworld (2001) and
Mazzarol, Choo and Nair (2001). In the case of recognition of
qualifications, Smart and Ang (1992) had conducted a study in
Singapore and found that students of Singapore and their parents
considered this factor. This result was supported by Lawley (1993)
and Mullins et al. (1995). In the case of standard and quality of
education, similar arguments were made by Eduworld (2001).
In India, there is scanty literature on these subjects.
Raychaudhuri and Prabir (2008) identified various hurdles in the
promotion of Indian higher education abroad, namely, the problem
of equivalence of degrees, visa issues, language problem, lack of
good residential facilities, good transport facilities, etc. Chanda
(2004) and Shrivastava (2006) argue that India has a future in
global competitiveness under the common platform of GATS.
Kaul (2006) points out the factors of the four modes of GATS
and its implications for the Indian education sector. He further
emphasises the necessity of negotiation for India and how long
it will be beneficial for the Indian economy as well. Agarwal
(2006) in his study covers all the issues regarding foreign direct
investment (FDI), the General Agreement on Trade in Services
(GATS), World Trade Organisation (WTO) and privatisation of the
sector. He argues in favour of exploiting the market through the
advantage of the vast potential of knowledge resources and quality
manpower in India.
 238•Shahid Ahmed and Sushil Kumar

Higher Education under

GATS and India’s Commitments
The General Agreement on Trade in Services is a multilateral
agreement that is based on the premise that progressive liberalisa-
tion of trade in commercial services will promote economic growth
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in WTO member countries. It provides legal rights to trade in all

services, except those (like defence) provided entirely by the gov-
ernment. The GATS agreement is made up of three parts. The first
part is the ‘Framework Agreement’ containing 29 articles, the sec-
ond part consists of ‘national schedules that list a country’s specific
commitments on access to the domestic market’ and the third part
consists of a ‘number of annexes, ministerial decisions, schedules
of commitment’, etc. Presently, GATS covers 161 activities falling
within 12 services, education being one of them.
A commitment in a services schedule is an undertaking
to provide market access and national treatment for the service
activity in question on the terms and conditions specified in the
schedule. When making a commitment a government therefore
binds the specified level of market access and national treatment
and undertakes not to impose any new measures that would
restrict entry into the market or the operation of the service. In
nearly all schedules, commitments are split into two sections:
First, ‘horizontal’ commitments which stipulate limitations that
apply to all of the sectors included in the schedule; these often
refer to a particular mode of supply, notably commercial presence
and the presence of natural persons. Any evaluation of sector-
specific commitments must therefore take the horizontal entries
into account. In the second section of the schedule, commitments
which apply to trade in services in a particular sector or sub-sector
are listed (WTO, 2011).
In the Uruguay Round, India made no commitments
on the higher education services. However, 100 per cent FDI in
higher education services on the automatic route is allowed in
India. Also, foreign participation through twinning, collaboration,
franchising, and subsidiaries is permitted. However, India included
higher educational services in its revised offer in August 2005. In
addition to the horizontal commitments, specific commitments are
prescribed in Table 10.1.
 Downloaded by [University of Toronto] at 13:44 15 January 2017

Table 10.1: Specific Commitments (India)—Higher Education Services

Limitations Additional
Service Limitations on
Description on National Commit-
Mode Market Access
Treatment ments
Mode 1: Cross-border Supply: delivery of education None subject to the condition that service providers None
services via internet (distance education, would be subject to regulations, as applicable to
tele-education, education testing services domestic providers in the country of origin.
Mode 2: Consumption Abroad: movement of students None None
from one country to another for higher educa-
tion (foreign students in US universities).
Mode 3: Commercial Presence: establishment of None subject to the condition that fees to be None
local branch campuses or subsidiaries by charged can be fixed by an appropriate authority
foreign universities in other countries, and that such fees do not lead to charging
course offerings by domestic private colleges capitation fees or to profiteering. Subject
leading to degrees at foreign universities, further to such regulations, already in place or
twinning arrangements, franchising. to be prescribed by the appropriate regulatory
authority.
In the case of foreign investors having prior
collaboration in that specific service sector in
India, FIPB approval would be required.
Mode 4: Movement of Natural Persons: temporary Unbound except as in the horizontal section. Unbound
movement of teachers, lecturers, and educa- except
tion personnel to provide education services as in the
overseas. horizontal
section.
Sources: Department of Commerce and Industry, Government of India, [Link] (accessed 18
July 2011).
Export Potential of India’s Higher Education Sector •2 3 9
 240•Shahid Ahmed and Sushil Kumar

India’s commitments on higher education basically restrict

any form of education that is beyond the purview of domestic
regulations, already in place or to be prescribed by the appropriate
regulatory authority. There is a need to restructure domestic
regulations if we are interested in inviting service providers from
other regions in this sector.
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Volume and Composition of the Flow of Services

Educational institutions as well as governments have become
increasingly aware of the positive effects associated with student
mobility. Although experiences differ among countries, the OECDs
share 80 per cent of worldwide foreign students as hosts (up
from 68 per cent in 1960, 69 per cent in 1970 and 73 per cent in
1980). It is important to recognise that about 70 per cent of the
world’s foreign students come from less developed countries, and
institutions in OECD countries host about 80 per cent of them.
Import on education services (education-related expenditure)
constitutes a significant share of service imports in developing and
least developed countries. Less developed countries spend more
money on the import of education services compared to developed
countries as a percentage of extended balance of payments services
(EBOPS). Detailed information is presented in Table 10.2.

Table 10.2: Imports of Education Services of Selected Countries in US$ Millions

(Partner World)

Import (Edu-
Total EBOPS
Period Country cation-related %
Services
Expenditure)
2009 Bhutan 72.98 16.81 23.03
2009 Bermuda 983.70 50.73 5.16
2009 Burundi 217.29 10.70 4.93
2009 Armenia 857.62 37.77 4.40
2009 Bangladesh 3417.00 106.00 3.10
2009 Georgia 974.00 28.00 2.87
2009 Cyprus 4136.36 107.06 2.59
2009 Bahamas 1196.04 29.84 2.49
2009 Czech Rep. 18887.29 447.22 2.37
(continued)
 Export Potential of India’s Higher Education Sector •2 4 1

(continued)

2009 France 127362.00 1938.28 1.52

2009 Germany 254727.00 3480.83 1.37
2009 Estonia 2526.54 31.71 1.26
2009 Bulgaria 5040.00 47.74 0.95
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2009 Hungary 16598.39 98.67 0.59

2009 Maldives 284.61 1.14 0.40
2009 Austria 36936.06 132.38 0.36
2009 Sweden 45655.61 124.27 0.27
2009 United Kingdom 163918.00 248.68 0.15
2009 Albania 2231.20 2.71 0.12
2009 Brazil 46973.72 49.03 0.10
2009 Belgium 73331.47 25.08 0.03
Source: Author’s calculation from United Nations Service Trade Statistics Database, available at
[Link] (accessed 9 April 2011).

For many countries, education has become a lucrative in-

dustry. With that, national governments have taken a keen inter-
est in the global mobility of higher education. In Australia, higher
education is the country’s second largest export, with an annual
revenue even outweighing tourism. In Canada, the presence of in-
ternational students provides employment for more than 83,000
Canadians. By the year 2025, almost eight million students are
projected to be studying outside of their home countries (Lim et
al., 2011). The reasons for increased global student mobility are
various and intertwined. Prospective students from the booming
economies of population-rich countries such as China and India
are increasingly looking to study abroad.
At the same time, the traditionally perceived destination
countries are shifting. While the US is still a major destination for
international students, enrolment by foreign students is decreasing.
Simultaneously, an ever increasing number of students are looking to
study abroad in China. Overall, the economic growth of developing
countries has made studying abroad affordable for millions of people
who didn’t have the option before. Around the world, the increasing
degree of wealth and rising GDP per capita encourages student
mobility for those who may not have seen it as a viable option before.
Table 10.3 presents international students’ mobility by
originating countries. If we analyse the composition of international
 Downloaded by [University of Toronto] at 13:44 15 January 2017

Table 10.3: International Flows of Mobile Students at the Tertiary Level

New
India Japan Germany France USA UK Canada Australia
Destination Zealand Total
2006 2008 2008 2008 2008 2008 2007 2008 2008
International students 2065 997 16814 105855 35692 32279 10479 321 7312 211814
from Africa (16.69) (0.79) (8.88) (43.48) (5.72) (9.44) (11.28) (1.02) (3.17) (11.19)
International students 0 2602 5479 8430 63066 23555 (0.00) 2864 7973 113969
from North America, (0.00) (2.06) (2.89) (3.46) (10.10) (6.89) (9.07) (3.46) (6.02)
Central America and
Caribbean
International students 18 1037 5483 8945 30950 3293 2348 251 2149 54474
242•Shahid Ahmed and Sushil Kumar

from South America (0.15) (0.82) (2.90) (3.67) (4.96) (0.96) (2.53) (0.80) (0.93) (2.88)
International students 8883 118124 62439 51021 419580 160715 44250 21106 182904 1069022
from Asia (71.79) (93.33) (32.98) (20.96) (67.19) (47.02) (47.64) (66.87) (79.30) (56.47)
International students 202 3267 84486 51909 70145 111909 10287 3185 10205 345595
from Europe (1.63) (2.58) (44.62) (21.32) (11.23) (32.74) (11.08) (10.09) (4.42) (18.26)
International students 76 541 414 385 5010 2191 332 3841 4236 17026
from Oceania (0.61) (0.43) (0.22) (0.16) (0.80) (0.64) (0.36) (12.17) (1.84) (0.90)
International students- 12374 126568 189347 243436 624474 341791 92881 31565 230635 1893071
Total (100) (100) (100) (100) (100) (100) (100) (100) (100) (100)
Source: Author’s calculation from UNESCO, [Link] (accessed 8 April 2011).
Note: Figures in parentheses are percentage of total.
 Export Potential of India’s Higher Education Sector •2 4 3

students hosted by the top nine countries, the majority of students

originate from Asia, Europe and the African region. However, the
mobility of students of European countries is mainly restricted to
UK, France, Germany, USA and Canada. A minority of European
students are interested in studying in Australia, New Zealand
and Japan, the favourite destinations for Asian students. If we
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examine the figures of student mobility into India, approximately

72 per cent were Asian and 17 per cent were African. Similarly,
approximately 94 per cent foreign students are of Asian origin in
Japan, 79 per cent foreign students are of Asian origin in Australia
and around 67 per cent foreign students are of Asian origin in
the United States and New Zealand. Except France where 43 per
cent foreign students are of African origin, India has the highest
proportion of African students’ enrolments.
Table 10.4 reports international student mobility (ISM) by
originating country. If we analyse the top countries of origin of
foreign students during 1995–2008, the rank of India was seventh
followed by Malaysia in 1995, but India’s rank was second followed
by China in 2005 and also in 2008. Destination patterns for ISM
seem to be more stable over time than the originating countries.
This reflects a well-known axiom in migration theory, which is that
migrants tend to go to places or countries where there are already
migrants of the same nationality or ethnic group: this applies to
international students as well (Dreher and Poutvaara, 2005).
Table 10.4: Top 10 Countries of Origin of Foreign Students, 1995–2008

Countries 1995 Countries 2005 Countries 2008

China 115,871 China 343,126 China 510,842
South Korea 69,736 India 123,559 India 184,801
Japan 62,324 South Korea 95,885 South Korea 115,464
Germany 45,432 Japan 60,424 Germany 94,408
Greece 43,941 Germany 56,410 Turkey 65,459
Malaysia 41,159 France 53,350 France 63,021
India 39,626 Turkey 52,048 Russia 58,983
Turkey 37,629 Morocco 51,503 Japan 52,849
Italy 36,515 Greece 49,631 US 52,328
Hong Kong 35,141 US 41,181 Malaysia 51,434
Source: OECD and UNESCO data compiled in de Wit, H. 2008. ‘Changing Dynamics of
International Student Circulation: Meanings, Push and Pull Factors, Trends, and Data’, in H. de
Wit, P. Agarwal, M. E. Said, M. T. Sehoole and M. Sirozi (eds), The Dynamics of International
Student Circulation in a Global Context, Rotterdam: Sense Publishers, pp. 33–34; and OECD
(2010), OECD Indicators, [Link] (accessed 15 May 2012).
 244•Shahid Ahmed and Sushil Kumar

After examining the broad trends of international students

at the global level, it is important to highlight the inflow and
outflow of students from India. Table 10.5 shows places of origin
and percentage of total international students enrolled in India.
Out of the top 10 countries, five countries are common in the
years 2004 and 2009. The present catchment origin is the African
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countries, South Asian countries and Gulf countries. India was

also able to bring a significant proportion of students from China
(4 per cent) in 2009. Iran has the highest share (13.6 per cent)
of international students enrolled in India in the year 2009. It
is a researchable issue whether it is the low cost and quality of
Indian education attracting students or the variety of constraints
imposed by EU and the United States on Iran. If we look at the
destinations and number of Indian students studying abroad in
the year 2009, 60 per cent of the total have chosen United States
as their destination while the combined share of United States,
Australia and the United Kingdom constitutes 91 per cent of Indian
students studying abroad. Only a little fraction of Indian students
have chosen developing countries such as Malaysia, Ukraine and
Kazakhstan (Table 10.6). Looking at India’s imports of education
services statistics, the education-related expenditure of total
Extended Balance of Payments Services (EBOPS) (imports) was
1.59 per cent in the 2001. This import expenditure was 3 per cent
in the year 2005 and 4.20 per cent in 2009 (Table 10.7).

Table 10.5: Top 10 Originating Countries by International Student Enrolment in India

2004 2009
Countries % Countries %
UAE 11.30 Iran 13.6
Nepal 10.19 Ethiopia 8.9
Iran 8.44 UAE 7.9
Bangladesh 7.1 Nepal 7.9
Oman 4.86 Afghanistan 5.5
Sri Lanka 4.38 Saudi Arabia 4.8
Mauritius 3.97 China 4.0
Saudi Arabia 3.15 Sri Lanka 3.4
Kenya 3.15 Bhutan 3.1
United States 2.90 Kuwait 2.2
Source: Atlas of Student Mobility. 2010. New York: Institute of International Education, avail-
able at [Link] (accessed 10 April 2011).
 Export Potential of India’s Higher Education Sector •2 4 5

Table 10.6: Top 10 Destinations and Number of

Students Studying Abroad from India in 2009

Countries Number
United States 94640
Australia 26520
United Kingdom 25901
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New Zealand 4094

Germany 3257
Ukraine 1785
Cyprus 1076
France 1038
Malaysia 897
Kazakhstan 782
Source: Atlas of Student Mobility. 2010. New York: Institute of International Education,
available at [Link] (accessed 10 April 2011).

Table 10.7: India’s Imports of Education Services in US$ Millions (Partner World)

Total EBOPS Education-

Period Reporter Services related %
(Imports) Expenditure
2001 India 14458.26 230.33 1.59
2002 India 15038.58 182.65 1.21
2003 India 17499.75 187.27 1.07
2004 India 25197.62 560.21 2.22
2005 India 32635.03 989.37 3.03
2006 India 40125.79 1080.41 2.69
2007 India 47782.00 2152.00 4.50
2008 India 56172.50 2629.00 4.68
2009 India 53772.00 2256.00 4.20
Source: Author’s calculation from United Nations Service Trade Statistics Database, http://
[Link]/unsd/ServiceTrade (accessed 9 April 2011).

Research Methodology and Data Sources

The empirical analysis of this study is based on secondary as well
as primary data. The main objective of econometric analysis based
on secondary data is to understand the major determinants of the
 246•Shahid Ahmed and Sushil Kumar

movement of students for education from different originating

countries to India. The inflow of students for education takes place
mainly from developing and least developed countries to India.
Also, the major area from where the movement to developed
countries originates is the developing world of Asia. However,
there are a few exceptions such as France, UK, etc.
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In this study, we have considered India as a destination coun-

try. The originating countries are Djibouti, Eritrea, Ethiopia, Kenya,
Mauritius, Uganda, United Republic of Tanzania, United States of
America, Iran Islamic Republic, Japan, Jordan, Korea Republic, Ma-
laysia, Mongolia, Oman, Thailand, United Arab Emirates, Vietnam,
France, Russian Federation, and the United Kingdom. The destination
country is chosen on the basis of availability of data for seven years
(2000 to 2006). We have estimated the following equation:
IMSjt  1  2PCIjt  3EXRTij,t  4GLOBALjt 5D1 6D2Ejt
where
i are regression coefficients with 2 >0, 3 <0, 4 >0 , 5 >0 and
6>0.
IMSjt is the dependent variable representing internationally mobile
students originating from least developed and developing coun-
tries j at time t.
PCYjt is per capita GDP at constant year 2000 for country j at time t.
EXRTij,t is the bilateral real exchange rate between country i and j
at time t.
GLOBALjt is a measure of openness that importing country j has to
the global economy at time t.
D1 is a dummy variable representing India’s agreement on student
exchange programmes with the other country.
D2 is a dummy variable of common language.
Ejt is the white-noise error term for country j in time t.
To estimate this equation, secondary data have been taken
from various sources. This study has taken data for internationally
mobile students from United Nations Educational, Scientific and
Cultural Organisation, Institute for Statistics, Statistical Yearbook
and the UIS publication entitled Global Education Digest. Per capi-
ta income (GDP per capita at constant prices, 2000, US$) has been
 Export Potential of India’s Higher Education Sector •2 4 7

taken from World Bank national accounts data (World Develop-

ment Indicators which is an online database). Exchange Rate data
have been drawn from World Bank national accounts data (World
Development Indicators, 2010). Real exchange rate has been cal-
culated as
Domestic Exchange Rate Foreign Prices (Pf)
Real Exchange Rate  ____________________  _________________
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Foreign Exchange Rate Domestic Prices (Pd)

The variable GLOBAL is derived by aggregating country
j’s openness to trade as a proportion of its gross domestic product
(GDP). Openness to trade is measured as the sum of exports (X),
imports (M), inward foreign direct investment (IFDI) and outward
foreign direct investment (OFDI). Thus, GLOBAL is derived as
follows:
Xjt  Mjt  IFDIjt  OFDIjt
GLOBALjt  _______________________
GDPjt
Data of exports, imports and gross domestic product have
been taken from World Bank national accounts data (World De-
velopment Indicators, 2010). Inflow of foreign direct investment
(IFDI) and outward foreign direct investment (OFDI) has been
drawn from United Nations Conference on Trade and Development
(UNCTAD, 2010). D1 and D2 are the dummy variables to capture
the effect of student exchange programme agreements with India
and dummy variable of common language. Information on student
exchange programme agreements with India has been taken from
the website of Government of India Scholarships for International
Students. D2 variable information has been drawn from the CEPII
website [Link] (ac-
cessed 16 February 2011).
It is difficult to identify barriers and opportunities on the
basis of secondary data. Hence, an attempt has been made to un-
dertake a primary survey from international students in India pur-
suing education in various Indian universities. A questionnaire was
designed for this purpose. Personal interviews are used to collect
primary data from international students in universities and IIT,
Delhi. The primary data are collected from five universities, name-
ly Jamia Millia Islamia University, University of Delhi, Jamia Ham-
dard University, Jawaharlal Nehru University, and Aligarh Muslim
University, and one technical institute, namely Indian Institute of
 248•Shahid Ahmed and Sushil Kumar

Technology, Delhi. We have taken data from 122 respondents, con-

sisting of 15 respondents from Jamia Millia Islamia, 30 respond-
ents from the University of Delhi, 15 respondents Jamia Hamdard
University, 18 respondents from Jawaharlal Nehru University, 29
respondents from Aligarh Muslim University, and 15 respondents
from the Indian Institute of Technology, Delhi. In the primary sur-
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vey, respondents belong to 31 countries, namely, Afghanistan,

Bangladesh, Cambodia, Canada, China, Eritrea, Ethiopia, France,
Germany, Ghana, Indonesia, Iran, Iraq, Italy, Japan, Jordan, Kaza-
khstan, Kenya, Laos, Myanmar, Mauritius, Nepal, Nigeria, Oman,
Saudi Arabia, South Korea, Sudan, Taiwan, Tajikistan, Thailand,
and Turkmenistan.

Empirical Analysis

Empirical Results Based on Secondary Data

On the basis of theory and empirics, it is revealed that higher per
capita income increases demand for foreign education in importing
countries probably to meet skilled labour requirements. Higher
relative cost of living has a negative influence on the potential
movers as expected. Hence, the exchange rate and mobility of
international students are expected to be inversely related. Greater
integration of an economy with other economies is also expected
to have a positive effect on the mobility of international students.
Obviously, cultural and education relations do have a positive
effect on the mobility of international students.
Panel regression results are presented in Table 10.8.
Econometric results show expected signs for the determining
variables. In the present study, panel regression results (random
effects) indicate that an increase in per capita income in originating
countries will increase demand for Indian education. The study
reveals that 1 per cent increase in the per capita income in the
originating countries may increase demand for Indian education
by 0.32 per cent. The ability to afford the cost of undertaking
offshore studies is a critical element in the decision of whether to
go overseas for higher education. This is increasingly a relevant
factor as higher education becomes more commercialised. Given
 Export Potential of India’s Higher Education Sector •2 4 9

the catchment geography of international students in developing

Asia and Africa, it is expected that India has a large number of
potential students in the times to come.
The other important variable in the present study is to
examine the effects of the exchange rate. The effect of exchange
rate on trade is well-established in the merchandise trade literature.
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Generally, the appreciation of the currency of an exporter relative

to the currency of an importer results in the deterioration of the
international competitiveness of the exporter. Theoretically, this
should not be any different for trade in services, including higher
educational trade. In the context of this study, it is hypothesised
that there is a negative relationship between the real exchange
rate (measured as the relative value of the exporting country’s
currency to the importing country’s currency) and the number
of international students from the importing country. The study
reveals that a 1 per cent rupee appreciation will decrease demand
for Indian education by 0.16 per cent in the originating countries.
The third variable of interest in this study is to capture the effect
of globalisation. As countries become more involved in the global
economy, more students are likely to study overseas. The present
study reveals that the higher the integration of the originating
economy in the global economy, the higher will be the inflow of
students.
Students seeking cross-border higher education in general
move from countries where the education system is less developed
to countries where the education system is more developed. This
is one of the reasons why cross-border mobility within a region
has been increasing. For example, students in the Arab countries
migrate to Egypt and Jordan to pursue their higher education
studies, and a large number of students from Bangladesh and
Nepal travel to India. To capture this aspect, there are two dummy
variables capturing common language and the educational
exchange agreement aspect in empirical analysis. If two countries
share a common official language (comlang_off), it is expected to
be positively related to more student inflows in the country. The
present study confirms the expected relationship. Similarly, more
students are expected from a country if a country has a student
exchange programme with India. The present study indicates a
positive relationship but this is statistically insignificant.
 250•Shahid Ahmed and Sushil Kumar

Table 10.8: Panel Regression Results (Random Effects)

Variable GLS_Coefficient ML_Coefficient

PCI 0.33 0.31
(2.07) (2.18)
Global 1.32 1.29
(4.26) (4.34)
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Exchange Rate 0.17 0.15

(1.87) (1.92)
Comlang_off (D1) 2.04 0.46
(3.45) (0.95)
D2 0.45 1.99
( 0.81) (3.84)
Cons 0.14 0.06
(0.09) (0.05)
R-sq: within 0.16
R-sq: between 0.27
R-sq: overall 0.27
Source: Author’s calculation from UNESCO, [Link]
[Link]?ReportId171 (accessed 8 April 2011).

Empirical Results Based on Primary Survey

On the basis of secondary data, it is not possible to predict ground
realities. Also due to dearth of published data, we have conducted
a field survey on international students for their perception about
Indian higher education. Figure 10.1 shows that the demand for
higher education in India mainly originates from least developed
countries. The reason behind the movement of students from least
developed countries to India is the low per capita income in these
countries and comparative low cost of study in India compared to
other countries.
To attract more international students, the destination
country needs to understand trends in this service and evaluate the
factors affecting the flow of foreign students. The aims of this field
study are to identify: sources of information about educational op-
portunities in Indian universities, courses, cost of study, difficul-
ties regarding study, scope of Indian university degrees regarding
employment, possibility of expending of higher education services
and identifying the major disincentive in higher education sector
 Export Potential of India’s Higher Education Sector •2 5 1

in India. To the best of our knowledge this type of study has not
been investigated previously regarding export of Indian higher ed-
ucation services.
Figure 10.1: Originating Countries of Students (in Percentage)
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17
Developed countries
15
Developing countries

68 Least developed countries

Source: Collected through field survey, 2011.

Cost of Education
One of the important factors influencing the country of choice
for cross-border education is the cost. With decreasing support
of government funding, cross-border education has become an
activity increasingly funded by individuals; the cost of and returns
to education have become important elements in deciding in
which foreign country to study. During the colonial period and
immediately afterwards, a flow was noted from colonies to the
imperial capital, mostly funded by governments and agencies.
Higher education in many of the host countries used to be tuition-
free. In fact, many countries did not have any provision for levying
fees from domestic and international students until the 1980s.
However, some of the countries, notably the UK, introduced fees
for overseas students, and countries such as Australia followed
suit. In some countries, a higher level of tuition fees is levied from
international students than from domestic students. Australia,
Canada, New Zealand, the UK, and the US are examples of this
pattern. However, some countries do not distinguish between
foreign and domestic students when fixing the fees. The fee level
remains the same for domestic and foreign students in France,
Greece, Hungary, Italy, and Japan and some countries such as
Denmark, Finland, Norway, and Sweden have not yet started
levying tuition fees from foreign students (OECD, 2006). In India,
the tuition fee is somewhat similar for foreign students across the
 252•Shahid Ahmed and Sushil Kumar

educational institutions in India. Students (nationals) of SAARC

countries pay much less than others, usually less than 50 per
cent. Indian Council of Cultural Relations (ICCR) provides liberal
scholarships to students from developing countries. But there are
quotas for different countries. Altogether, there are about 2,322
scholarships of various types offered by the Government of India.
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Quite consistent with the trend, the survey found that

the fees structure in Indian institutes is lower than those offered
by the institutes of developed countries (Table 10.9). On an
average, tuition fee in India is US$ 1,487.11 which is much
below the tuition fee in the developed world. For example,
annual tuition fees of a postgraduate course in humanities and
social science in developed countries in 2005 were as follows:
US$ 10,000–30,000 in US, US$ 30,000–45,000 in UK, and US$
10,000 to 40,000 in the Netherlands (Chaudhary and De, 2008).
If we examine the tuition fee only for a postgraduate course in
humanities and social science in India, this is even less than US$
1,487.11 per annum.

Table 10.9: Cost of the Study

Description Average Cost of Study (US $)

Average Tuition Fee 1487.11
Average Cost of Study India* 4159.52
Average Cost of Study United States** 40217.71
Average Cost of Study Australia** 31434.1
Average Cost of Study China** 13566.36
Source: Collected through field survey, 2011.
Note: *Cost of study calculated from the primary Data
**Cost of study based on IDP Education Australia, Comparative Cost of Higher Education in
the Higher (2004)

Table 10.9 presents the average cost of study in India. The

study revealed that the cost of study in India is far less compared
to other nations. It is revealed by primary survey that the average
cost of study in Indian universities is US$ 4,159 per annum. The
components of the cost are tuition fee, cost of food, accommoda-
tion cost, and books, reference materials and students’ travel cost.
Despite marginal differences among institutes, the average cost of
 Export Potential of India’s Higher Education Sector •2 5 3

study in India is cheaper compared to other countries. In India,

total cost of study per student per annum was only 10 per cent of
the US, 13 per cent of Australia and 30 per cent of China in 2004.
This difference may have gone up as most of the developed coun-
tries have hiked the fees during this period while there may be a
marginal increase in India during this period.
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Table 10.10 indicates barriers/disincentives faced by for-

eign students in India. On the basis of the primary survey, there
are varieties of barriers in institutes of higher learning. The pri-
mary data indicate that 61.7 per cent respondents identified the
language barrier as a significant barrier, followed by 40 per cent
respondents who identified high cost of living as a significant
barrier. The other major factors which act as disincentives for ISM
are high cost of study, lack of necessary study materials and poor
quality of the faculty members.

Table 10.10: Selected Barriers/Disincentives for Foreign Students in India

Factors %
Language barrier 61.7
High cost of living 40.2
Lack of necessary study materials 40.2
Poor quality of faculty members 32.8
Lack of laboratory & research facilities 32.8
High cost of study 21.3
Source: Collected through field survey, 2011.

Sources of information not only provide information about

study options abroad but also may influence them in making a
decision to enrol in a destination country. Figure 10.2 shows that
about 44.1 per cent respondents have got information about the
admission and courses offered in Indian universities through
their friends and relatives. This reveals two important aspects.
First, it assures us about the quality because parents and friends
recommend Indian education institutes for their children and
friends. Second, it also implies that we have little or no advertising
system to provide the information regarding the courses, cost and
other related information to foreign students.
 254•Shahid Ahmed and Sushil Kumar

Figure 10.2: Source of Information about the Courses in

Indian Universities (in Percentage)

3.3 8.2
21.1
Advertisements
22.1
Educational fairs
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Internet surfing

44.1 Family and friends

Through institutions

Source: Collected through field survey, 2011.

Table 10.11: Sponsors of Studies In India

Sponsor of Studies in India %

Parents 69
Government of originating country 14
Indian government 17
Source: Collected through field survey, 2011.

Table 10.11 shows that 69 per cent students were sponsored

by parents. The scholarships from India are limited in number
and small in value. Literature shows a positive relation between
scholarships and the movement of international students. The
international higher education service in Australia has emerged
since the 1950s from ‘aid programmes’ for overseas students
through the Colombo Plan (Wick, 1972). The policy on overseas
students in Australia has been changed from ‘aid’ to ‘trade’ after
the new overseas students policy was announced in March 1985
(Nesdale et al., 1995). In this context, the Indian government
should increase the number of scholarships for making its brand
name in other nations, particularly in Asia and Africa.
Table 10.12: Rating of Indian University Degrees in Comparison to
Universities in Developed Countries

Ratings %
High 19
Average 61
Low 20
Source: Collected through field survey, 2011.
 Export Potential of India’s Higher Education Sector •2 5 5

Table 10.12 shows the rating of an Indian university degree

compared to degrees of universities in developed countries. The
majority of respondents (61 per cent) rate Indian university degrees
as average compared to the degrees of developed countries. This is
a well-known truth and apex bodies and universities have to work
hard to earn a reputation in the global education system. Some
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gains may be achieved by transparency and proper information.

Indian universities should focus more on demand-oriented study
programmes.
Table 10.13 further shows the quality of Indian universi-
ties compared to other South Asian countries. The present study
revealed that about 83 per cent respondents said that India is an
emerging power in the higher education sector in Asia. It means
India is a favourable destination for foreign students. About 66 per
cent respondents will give preference for further study in India.
India has absolute and comparative advantage in the education
quality and fee structure. It implies that India has a comparative
advantage within South Asia in quality and cost of education. It
also indicates that India has the potential to expand the exports of
higher education to South Asia.

Table 10.13: Higher Education in India Compared to South Asian Context

Parameters Percentage of “Yes”

Quality of education of the Indian universities 79
within South Asia
Indian universities’ fee structure of the higher education 81
is less compared to other South Asian Countries
India is emerging hub of higher education in Asia 83
Preference for further study in India 66
Source: Collected through field survey, 2011.

Concluding Remarks
This chapter attempts to generate a discussion on India’s export
potential in education services. The present study reveals that
India has a great potential of export of higher education services
to least developed and developing countries. The secondary data-
based panel regression results indicate that higher per capita
income increases the demand of Indian higher education services.
 256•Shahid Ahmed and Sushil Kumar

The majority of consumers of Indian education services reside in

least developed countries where there is huge untapped growth
potential in the days to come. This implies that as the per capita
income in African and South Asian countries increases the Indian
education sector will gain. It also gives a positive signal to potential
internationally mobile students regarding future opportunities in
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India. Common cultural and language relations across the nations

will benefit India as well. Student exchange programmes will
enhance the visibility of the Indian education sector.
The present study revealed the fees structure in Indian
institutes is lower than those offered by the institutes of devel-
oped countries. The average cost of study in Indian universities is
$4,159 per annum which is quite low compared to other nations.
The study revealed that the important factors behind choosing
India as a place of study is the recommendation by others, cost of
courses and quality of Indian education. However, there is a need
of proper dissemination of information regarding admission in var-
ious courses, content of courses and also emerging opportunities
in institutions of higher learning in India in this context. Indian
embassies in other countries should relate information, organise
education fairs abroad. Finally, it is safely inferred that India has
potential in trade in education services if policy makers strategise
appropriately in the light of global education needs.
To make Indian education institutions of higher learning
competitive, there is a need for a liberalised and transparent FDI
policy in this sector. If the government wants to improve the edu-
cational sector it will have to invite not only foreign universities
but also foreign investment. It will not only increase the attraction
among students to study in India but will also save more than $10
billion that is spent by Indian students who go abroad for studying.
Many good universities would come up with winning programmes
that would give a global exposure to Indian students. Despite the
fact that a liberal FDI environment is emerging over time, there
are many barriers such as the fact that foreign institutions cannot
form a trust or society under Indian law as this is the first step
to buy a land to start an institution; a foreign university cannot
confer a degree in India; funds can be received from an interna-
tional society only after clearing a large number of hurdles. Finally,
India can adopt an education aid programme for promoting Indian
 Export Potential of India’s Higher Education Sector •2 5 7

education abroad as a first stage. India will earn revenue from the
export of higher education services in due course of time.

Notes
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1. Article I.2 of the GATS defines four modes of supply in any service
sector trade. The four modes are defined according to the location of
the provider and recipient.
2. This essay falls in the category of Consumption Abroad category of
GATS. This provision of GATS provides the service where the consum-
ers move to the country of the service supplier. In this study, an at-
tempt has been made to understand the major determinants of move-
ment of students for education from different originating countries
to India. The students who go to another country to study currently
represent the largest share of the global market for education services
and the numbers are growing.

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Chanda, R. 2004. ‘GATS, Higher Education Services, and India’, Working
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org/[Link]?id0453024D&showarchive
 11
Changing Pattern of Country
Competitiveness in Trade in Computer and
Information Services
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Jayesh N. Desai

S
tructural change in the composition of the world’s foreign
trade has been taking place in the recent past. Services have
been contributing to a larger part of the world GDP for a while
now, still, the contribution of services to world trade has been very
less due to the non-tradability of services. However, developments
in information and communication technology (ICT) have made
it possible to ‘splinter off’ services embodied in the provider and
made it possible to deliver it through telecommunication networks
at distant locations. These developments have given rise to the
phenomenon called outsourcing of services.
Services which have emerged as a dynamic part of trade
today were until recently an ignored part of international trade. This
neglect for trade in services had its origin in the perception, amongst
many other factors, that services are non-tradable. However, this was
never a correct assessment. Travel and transportation had always
been essential and significant components of trade (Hoekman and
Braga, 1997). Even though, other forms of services have not been
traded much. Nevertheless, developments in ICT have to ‘splin-
ter off’ services embodied in the provider and made it possible to
deliver it through telecommunication networks at distant locations.
These developments have given rise to trade in business services,
particularly in computer- and information-related services (CIS).
This emergence of the outsourcing of business services, as
one of the fastest growing sectors of international trade today, has
induced both developed and developing countries to come forward
as major participants in this dynamic sector (Mattoo and Wunsch-
Vincent, 2004).1 Initial explanations for the success of developing
countries in trade in services was provided by Kravis et al. (1983)
and Bhagwati (1984b). They made early attempts to inquire into
the reasons for the relative expansion of services employment and
 Changing Pattern of Country Competitiveness •2 6 1

reasons for relatively lower price structure for services in poor

countries as compared to rich countries. They found that in devel-
oping countries, there is ample supply of relatively skilled labour
leading to low wages. Since the technology for producing and
delivering services is almost similar across the countries, the lower
cost of labour results in cheaper services in developing countries as
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compared to developed countries.

Deardorff (1985) and Melvin (1989) tried to evaluate
theoretical validity and applicability of principles of comparative
advantage and the Heckscher-Ohlin model of factor endowment
to trade in services, respectively. The aim of these studies was
to understand whether trade in services can be explained using
conventional tools of trade theories developed for merchandise
trade. Both these studies found that while existing trade theories
can be used to explain the larger part of trade in services, in some
cases they remain indecisive in explaining the pattern of trade in
services and require some adjustment.
The rapidly increasing services trade has also elicited
the attention of policy makers and policy researchers. Bhagwati
(1984a) has termed the notion of bringing services under the ambit
of the GATT while still continuing the world regime of immigration
restrictions as a deceitful act. Nevertheless, he believes that free
trade in services is still possible and fast developing countries,
amply endowed with skills, will have a comparative advantage
in free trade in services transmitted through wires. On the other
hand, Langhammer (2002) contradicted the perception that
trade in services in general, and developing countries’ exports in
services in particular, are dynamic segments of world trade. Both
total trade data as well as US import trade figures do not support
this perception and some recent success stories may turn out to be
country- and time-specific. Langhammer’s study raised questions
over the sustainability of recent trends in trade in ICT-enabled
services and the perception about the emergence of developing
countries in the international trade arena. Due to this the need
for the evaluation of the competitiveness of different countries in
trade in ICT-enabled services has also arisen. In this milieu, this
study was conducted to investigate the performance of different
developed and developing countries in CIS. The ex-post nature of
the study provides an appropriate starting point for evaluating past
policies to promote the sector. An insight into changing patterns of
 262•Jayesh N. Desai

competitiveness in CIS at the world level should also provide some

inputs for future policies to promote the sector.
This chapter studies the changing patterns of country
competitiveness in trade in CIS. The second section provides a
detailed description of research methodology used in this research;
it also provides a detailed description about scope of this study,
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sources of data and analytical tools used for evaluating country

competitiveness in CIS. The third, fourth and fifth sections evaluate
country competitiveness in CIS. The third section uses the size of
trade, growth in trade to measure performance in CIS. The fourth
section examines the competitiveness of a country with the help
of Revealed Comparative Advantage (RCA) enjoyed by specific
countries in trade in CIS, and the fifth section assesses relative
movement in World Market Share (WMS) of different countries
in CIS to measure competitiveness of countries. Finally, the sixth
section concludes the study.

Research Methodology
This study uses the positivist paradigm to evaluate country
competitiveness in trade in business services. It carries out ex-post
analysis of secondary trade data in business services to examine
the pattern of trade. In order to effectively compare performance
in trade in business services, first, a few leading countries are
identified for better comparability. However, due to the amorphous
nature of the concept of competitiveness, identifying leading
countries in international trade in any sector is a challenge. In this
research, to identify leading countries in trade in business services,
two different sets of parameters are used:
(a) Countries which ranked amongst the top 13 countries in
terms of their size in trade in services in the three categories
of services trade are included in this study — total services,
CIS and Other Business Services in 2007.2 The countries
which were selected based on this criterion are China, France,
Germany, India, Ireland, Netherlands, Spain, UK, and US.
(b) Countries which consistently ranked in the top 10 in leading
research and consultancy firm A. T. Kearney’s Global
Location Index of 2004, 2005, 2007, and 2009. The
countries which were selected based on this criterion are
Chile, China, India, Malaysia, Philippines.
 Changing Pattern of Country Competitiveness •2 6 3

Thus, based on these two criteria 12 countries — Chile, China,

France, Germany, India, Ireland, Malaysia, Netherlands, Philippines,
Spain, United Kingdom (UK) and United States of America (USA) —
are included in this investigation of competitiveness of different
countries in business services. It is important to note here that two
countries — India and China — get qualified based on both the
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criteria used for selection of countries in this study representing the

capability and prominence of these countries in the sector.
This study aims at understanding the pattern of com-
petitiveness of countries in CIS, as included in the UN Services
Database (UNSD).1 Data for CIS are compared for the period of
2000–2008. These secondary data are sourced from UNSD, WTO
Statistics Database (WSDB), RBI Database and OECD Database.
Here it is important to note that these databases are likely to have
limitations in data coverage and accuracy.
To understand the changing competitiveness of different
countries in business services, different tools are used. The
study compares different countries’ trade in business services
in terms of their relative sizes and growth rate. It also analyses
comparative advantage in business services enjoyed by each of
the selected countries with the help of Revealed Comparative
Advantage (RCA) measures. Here, four alternative RCA measures
— Ballassa Index (BI), Relative Export Advantage (LnRXA),
Relative Trade Advantage (RTA), and Revealed Competitiveness
(RC) — are used to evaluate each country’s RCA in CIS and Misc
BPT services. The direction and extent of the changes in market
share also provide an indication of the competitive impact of a
particular entity. Therefore, here, movement in each country’s
world market share in trade in business services is also analysed
to understand the trends in a country’s competitiveness in trade
in business services.

Country Comparisons in Relative Trade

Performance in Computer and Information
Services (CIS)
Competitiveness of industry is defined by D’Cruz and Rugman
(1992) as the collective ability of firms in that sector to compete
internationally. Using this definition to measure competitiveness
 264•Jayesh N. Desai

of business services, the export performance of selected countries

in different services categories of interest is compared. However,
Chaudhuri and Ray (1997) have argued that the implicit
meaning of the collective ability of firms in that sector to compete
internationally is not limited to the ability of firms to export but
also substitute imports. Therefore, a competitive industry should
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be able to maintain a positive balance of trade. In line with this

argument, the comparison of countries with respect to their import
and net trade performance is also carried out apart from export
performance.
In the new millennium, during the period of this study,
2000–2008, trade in total services which was earlier considered to
be non-tradable has increased from $1,492.61 billion to $3,879.82
billion at a cumulative average growth rate (CAGR) of 12.8 per
cent. During the same period of time trade in CIS has grown from
$42.88 billion to $202.46 billion at a CAGR of 19.9 per cent. Thus
trade in CIS has increased at a higher rate than trade in total
services. In this section an attempt is made to understand the
relative trade performance of countries in CIS.
A comparison of rankings in exports of CIS in the
years 2000 and 2008 suggests that US was the top exporter in
CIS in the year 2000 followed by India, Ireland and UK. This
ranking changed in the year 2008; according to new rankings
India, Ireland, Germany, and UK surpassed US in CIS exports
and ranked 1st, 2nd, 3rd and 4th respectively while the rank
of US dropped to 5th. Other countries which improved their
relative position in CIS during 2000–2008 are Netherlands and
China. Countries which could maintain their relative ranks in
CIS are UK, Malaysia, Philippines, and Chile. The countries
which experienced a decline in their relative ranking in exports
of CIS are US, Spain and France. In the case of imports of CIS,
US, Germany and UK have sustained a high level of imports
demand for CIS and they have been the top three importers
of CIS during 2000–2008. Similarly Malaysia, Philippines and
Chile have remained the smallest importers of CIS with rank
10th, 11th and 12th respectively. Netherlands, India and China
increased their ranking in imports while Spain, France and
Ireland reduced their relative ranking in imports of CIS.
 Changing Pattern of Country Competitiveness •2 6 5

Table 11.1: Ranking of Selected Countries in Export Performance in CIS in 2000

and 2008 (Figures in $ Million)

2000 2008
Rank Country CIS Exports Rank Country CIS Exports
1 US 6948.96 1 India 49034.000
2 India 6341.00 2 Ireland 35211.883
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3 Ireland 5495.67 3 Germany 15457.185

4 UK 4331.12 4 UK 13442.463
5 Germany 3791.23 5 US 13389.849
6 Spain 2046.25 6 Netherlands 6738.240
7 Netherlands 1159.02 7 China 6252.062
8 France 805.23 8 Spain 6155.738
9 China 356.00 9 France 1850.851
10 Malaysia 82.00 10 Malaysia 1031.000
11 Philippines 76.00 11 Philippines 400.000
12 Chile 33.40 12 Chile 95.970
Source: Based on data from UNSD database available at [Link]
servicetrade/ and OECD database at [Link] [Link]
aspx?themetreeid=-200 (accessed 2 May 2011).

Table 11.2: Ranking of Selected Countries in Import Performance in CIS in 2000

and 2008 (Figures in $ Million)

2000 2008
Rank Country CIS Imports Rank Country CIS Imports
1 US 6230.47 1 US 16823.232
2 Germany 4952.09 2 Germany 13755.531
3 UK 1266.81 3 UK 6271.132
4 Spain 1227.20 4 Netherlands 5806.100
5 Netherlands 1183.90 5 India 3787.000
6 France 744.43 6 China 3165.131
7 India 591.00 7 Spain 2848.003
8 Ireland 276.40 8 France 2251.601
9 China 265.00 9 Ireland 1041.126
10 Malaysia 201.00 10 Malaysia 899.000
11 Philippines 99.00 11 Philippines 80.000
12 Chile 78.30 12 Chile 70.916
Source: Based on data from UNSD database available at [Link]
servicetrade/ and OECD database at [Link] [Link]
aspx?themetreeid=-200 (accessed 2 May 2011).
 266•Jayesh N. Desai

Figure 11.1: Comparing Growth Rates of Trade in CIS during 2000–2008

Export Import

3.63

28 26.6 29.2 29.3

23.4 26.2
21.2 20.3 21.7 20.5 19.9
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17.6
13.7 16.3 13.7
16
13.7
10.9 10.1 11.7 12.2
9.6 9
2.3

3.2
le

ce

n
ia

et ysia
na

Ph nds

s
y

S
nd

ld
K
ne

ai
an
hi

U
U
an

or
hi

Sp
In

la
C

rla

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a
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al

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Source: Own calculation of data based on data from UNSD database available at [Link]
[Link]/unsd/servicetrade/ and OECD database at [Link] [Link]
[Link]?themetreeid=-200 (accessed 2 May 2011).

If performance is analysed based on growth rates of imports

and exports then China experienced the highest growth rate in
exports as well as imports of CIS; however, this has been on a very
small initial base of trade. Amongst the top five countries only India
and Ireland experienced a growth rate above the world average of
19.9 per cent with India having a substantial higher growth rate of
26.6 per cent as compared to Ireland which experienced a growth
rate of 21.8 per cent in exports of CIS. The US, UK and France are
the three countries which saw a higher growth in imports than
exports. Based on this performance, India, Ireland, UK, Spain were
the four countries which had the highest net trade balance in CIS.
Five countries — Philippines, Netherlands, Chile, Malaysia, and
Germany — had a trade deficit in 2000. All of these countries
improved their net trade performance and were able to convert
their trade deficit in CIS to net trade surplus in 2008, whereas
US and France had a trade surplus in 2000 but trade deficit in
2008. Thus India and Ireland have exhibited strong relative trade
performance in CIS while US and France have remained clear cut
laggards. Newer and smaller players like Malaysia, Philippines and
Chile were able to demonstrate a good performance in trade in
CIS, particularly in curtailing their imports. However, they remain
marginal players in the sector.
 Changing Pattern of Country Competitiveness •2 6 7

Table 11.3: Ranking of Selected Countries in Relative Trade Performance in CIS

during 2000 and 2008 (Figures in $ Million)

2000 2008
Rank Country Net Trade Rank Country Net Trade

1 India 5750.0 1 India 45247.000

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2 Ireland 5219.3 2 Ireland 34170.757

3 UK 3064.3 3 UK 7171.330
4 Spain 819.1 4 Spain 3307.735
5 US 718.5 5 China 3086.931
6 China 91.0 6 Germany 1701.654
7 France 60.8 7 Netherlands 932.141
8 Philippines 23.0 8 Philippines 320.000
9 Netherlands 24.9 9 Malaysia 132.000
10 Chile 44.9 10 Chile 25.054
11 Malaysia 119.0 11 France 400.750
12 Germany 1160.9 12 USA 3433.383
Source: Based on data from UNSD database available at [Link]
servicetrade/ and OECD database at [Link] [Link]
aspx?themetreeid=-200 (accessed 2 May 2011).

Country Comparisons in Comparative Advantages

in the Business Services Based on Revealed
Comparative Advantages (RCA)
A country’s competitiveness in a particular industry in international
markets can be attributed to its comparative advantage in that
particular sector and therefore understanding the causes and
extent of the comparative advantage (CA) of different nations is
central to the study of international trade and competitiveness.
This notion of comparative advantage can be attributed to the work
of David Ricardo (1817). Ricardo argued that countries apply their
resources to the most productive use and therefore they will not
always apply their resources to sectors where they have absolute
advantage but will allocate their resources to those sectors in which
their relative efficiency is higher. However, direct measurement of
 268•Jayesh N. Desai

CA is an obscure and complex task which is dependent on a number

of factors some of which are observable and some not. Therefore
instead of using general principles of trade theory to explain trade
flow, Balassa (1965) focussed on observed trade as he believed
that CA can be ‘revealed’ from real world trade patterns. Balassa
(1977) further explained that if the notion that a country’s trade
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performance is governed by its CA is true then the international

trading pattern in a particular commodity reflects inter-country
difference in relative costs as well as non-price factors, and direct
observation of trade performance should ‘reveal’ CA (RCA). In
this milieu, to understand competitiveness of different countries
in business services, RCA measures are used to understand their
comparative advantage.

Measures of Revealed Comparative Advantage

The competitiveness of a specific industry of any country in the
international market is attributed to the level of comparative
advantage enjoyed by the country in that particular industry.
Therefore to understand competitiveness of the country in the par-
ticular industry it is important to measure comparative advantage.
Nonetheless, it is extremely difficult to directly measure the CA of
a country in a particular industry; to overcome such limitations,
Balassa (1965) proposed to use actual trade as he believed that the
CA of a country gets manifested from it. He proposed a compre-
hensive measure for RCA which is presented here as RCABI.
RCABI = (Xij / Xit)/(Xnj / Xnt) = (Xij / Xnj)/(Xit / Xnt) (1)
Here X represents exports, i is a country, j is a commodity and n is
a set of countries and t is a set of commodities.
RCABI measures a country’s exports of a commodity
relative to its total exports and corresponding export performance
of the world. Here, if a country has RCABI> 1 in a commodity then
it can be said that comparative advantage is ‘revealed’, however,
if RCABI< 1 then the country is supposed to have a comparative
disadvantage in that commodity.
RCABI is considered to be limited as it focusses only on
export trade while completely ignoring imports. Vollrath (1991)
offered three alternative measures for calculating a country’s RCA,
which he called the Relative Trade Advantage, the logarithm of
Relative Export Advantage and the Revealed Competitiveness
 Changing Pattern of Country Competitiveness •2 6 9

which is expressed as a logarithm of Relative Export Advantage

minus logarithm of Relative Import Advantage (LnRMA). These
three measures were projected as alternative definitions of revealed
comparative (competitive) advantage and proposed as follows:
RTA = RXA  RMA (2)
where RXA = (Xij /Xit’)/(Xn’j/ Xn’t’)
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RMA = (Mij /Mit’)/(Mn’j/ Mn’t’)

RTA = (Xij /Xit’)/(Xn’j/ Xn’t’)  (Mij / Mit’)/(Mn’j/ Mn’t’) (3)
Vollrath’s (1991) second RCA measure is a logarithm of Relative
Export Advantage.
LnRXA= ln(Xij / Xit’)/(Xn’j/ Xn’t’) (4)
Vollrath’s (1991) third RCA measure, Revealed Competitiveness,
is expressed as
RC = ln RXA  ln RMA
= ln[(Xij / Xit’)/(Xn’j/ Xn’t’)]ln[(Mij / Mit’)/(Mn’j/ Mn’t’)] (5)
Here, in the equations (2), (3), (4) and (5), RXA and RMA
represent Relative Export Advantage and Relative Import Advantage.
A country is represented by ‘i’ and ‘j’ refers to a commodity. All
countries minus country ‘i’ are represented by ‘n’ and ‘t’ refers to all the
traded items minus commodity ‘j’. Thus Vollrath’s (1991) RCA index
eliminates country-commodity double counting in world trade. These
RCA indexes also make a more obvious distinction between a specific
country and the rest of the world in terms of their performance in
trades of one specific commodity vis-à-vis all other commodities. A
positive RCARTA, RCALnRXAand RCARC reveal a comparative advantage
whereas negative values reveal a comparative disadvantage.
Ricardo’s comparative advantage is based on a country’s
greater relative specialisation in a particular sector and lowest
opportunity cost in producing in a particular sector. To identify
the level of specialisation of countries in the study with respect
to business services, their RCAs are calculated. In this study RCA
based on Balassa Index, here RCABI, and Vollrath’s (1991) three
measures of RCA, here RCALnRXA, RCARTA and RCARC are measured
for trade in CIS, and miscellaneous business, professional and
technical services.2 The various RCA indices for CIS and Misc BPT
services are presented in the next section. As discussed earlier,
these indices are used for identifying whether a country enjoys
 270•Jayesh N. Desai

comparative advantage in a particular sector or not. In this regard,

Balassa Index (BI) > 1 indicates RCA where as BI < 1 indicates
revealed comparative disadvantage (RCD) for a country in trade
for that particular sector. The other three indices, LnRXA, RTA and
RC indicate RCA for a country in a particular sector when index
value is > 0 and RCD when index value is < 0.
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Analysing Industry Competitiveness in Computer

and Information Services (CIS) through Revealed
Comparative Advantage (RCA)
In today’s era, CIS has emerged as a dynamic component of busi-
ness services. Due to increasing developments in ICT and the stand-
ardised technical nature of CIS, they are frequently outsourced
from low cost overseas destinations. Here, RCA measures of differ-
ent countries in CIS are calculated for evaluating their comparative
advantage in the sector. RCA indices for 12 countries in this study
are presented. In this section, to evaluate competitiveness in CIS
enjoyed by different countries in the study, each country’s yearly
RCA in CIS is calculated for the period 2000–2008. For comparing
RCAs, each country’s mean RCAs and standard deviation in RCAs
for the period are calculated and presented in Table 11.4. Trends in
RCA performance of countries under study are presented in Figure
11.2 by multiple line charts for the panel of countries.
According to these measures, only three countries —
India, Ireland, and UK — have a comparative advantage in all RCA
measures pertaining to trade in CIS indicating their competitive
strength in CIS. Further, two countries — Spain and US — have
comparative advantage in export-only measures of RCA but not in in
net trade–based measures of RCA. This dichotomy of simultaneous
existence of RCA in export-only measures of RCA and RCD on net
trade basis indicates that there might be quite a large amount of
intra-industry trade taking place and different players specialise in
services at different levels of the value chain making them producers
and consumers of the same category of services. Six countries —
Chile, China, France, Malaysia, Netherlands, and Philippines have
revealed comparative disadvantages in all measures of RCA in
CIS. As it can be seen in Figure 11.2, India and Ireland are the
top two countries with an unusually high RCA in CIS exports as
well as net trade measures. India, and Ireland at its peak in 2003,
 Downloaded by [University of Toronto] at 13:44 15 January 2017

Table 11.4: RCAs of Different Countries in Computer and Information Services

Means Standard Deviation

Country BI LnRXA RTA RC BI LnRXA RTA RC
Chile 0.2495 1.5145 0.3352 0.8339 0.1297 0.5176 0.2638 0.3893
China 0.3047 1.2519 0.2529 0.5995 0.0587 0.1877 0.1858 0.3416
France 0.3486 1.1157 0.3834 0.7745 0.0747 0.2535 0.0823 0.1638
Germany 1.0031 0.0048 1.8661 1.0418 0.1382 0.1498 0.4529 0.1419
India 19.2802 3.3245 25.4877 2.4615 2.1438 0.1104 3.6824 0.3535
Ireland 14.2620 2.9536 18.2545 2.8033 1.7644 0.1830 3.4660 0.3645
Malaysia 0.3125 1.2268 0.4505 0.9305 0.0936 0.3573 0.1196 0.3169
Netherlands 0.9095 0.1393 1.1475 0.8393 0.2622 0.3229 0.3090 0.2059
Philippines 0.2700 1.5648 0.1285 0.5343 0.2083 0.7366 0.3332 0.9824
Spain 1.7182 0.5475 0.1954 0.0913 0.3266 0.1955 0.4438 0.2367
UK 2.1643 0.8291 0.8075 0.4380 0.3571 0.1814 0.3749 0.2020
USA 0.9776 0.0387 0.5732 0.4765 0.1845 0.2090 0.2419 0.2193
Total 3.4833 0.0665 3.2681 0.0349 6.1361 1.6139 8.6259 1.3147
Source: Author’s calculation.
Changing Pattern of Country Competitiveness •2 7 1
 Downloaded by [University of Toronto] at 13:44 15 January 2017

Figure 11.2: RCAs of Different Countries in Computer and Information Services during 2000–2008

Country

Netherlands Philippines
Chile China France Germany India Ireland Malaysia Spain UK USA
35.0000

30.0000
272•Jayesh N. Desai

25.0000

15.0000

20.0000

10.0000

5.0000

0.0000

⫺5.0000
20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20
00 03 06 00 03 06 00 03 06 00 03 06 00 03 06 00 03 06 00 03 06 00 03 06 00 03 06 00 03 06 00 03 06 00 03 06
Year
BI nRXA RTA RC
Source: Own calculation of data based on data from UNSD database available at [Link] OECD database at OECD.
StatExtracts [Link] (accessed 2 May 2011).
 Changing Pattern of Country Competitiveness •2 7 3

witnessed exceptionally high RCAs. India had an RTA of 34.56 and

Ireland had an RTA of 23.91 in 2003, after which it has moderated
a bit. An investigation of inter-year volatility in RCAs for different
countries has indicated that different countries show different
realities. Countries like Germany and US have moved from RCA
to RCD over 2000 to 2008 in terms of export-only RCA measures
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while maintaining a disadvantage in net trade measures. The

Netherlands has experienced a fluctuating comparative advantage
in exports of CIS. Countries that improved their competitiveness in
net trade are the Philippines and Spain. They converted RCD in net
trade to RCA during the period of study.

Understanding Competitive Outcomes through

Relative Market Share Analysis
A common practice in business is to use market share and
changes in it to understand firm-level competitive performances.
This measure can be equally applicable in analysing countries’
competitiveness in international markets. One can get an insight
into the competitive performance of a country by comparing the
relative market share of a country in the global market or specific
markets against their relevant competitors. The direction and extent
of the changes in market share can also point out the competitive
impact of a particular country on others (Lall and Albaladejo,
2004). Therefore, this section investigates the competitiveness
of countries in the outsourcing of the services sector, use of the
WMS of respective countries and their relative movements. First,
just relative movement in WMS is used to identify movements in
competitiveness in the sector amongst countries in the study and
then different countries are mapped on three dimensions — change
in WMS and export growth rates during the period of study and
total size of exports in the sector at the end of the period of study.

Relative Movements in World Market Share in Services

amongst Countries in the Study
In order to understand the competitiveness of different countries in
business services, here, a matrix of competitive interaction devel-
oped by Lall and Albaladejo (2004) and Lall and Weiss (2005) is
 274•Jayesh N. Desai

used with suitable adaptation. This framework helps in mapping

different countries under study based on their relative performance
in the international market as compared to a reference country. In
order to comply with this framework, India is used as the refer-
ence country. According to this framework, the WMS of a reference
country (in this case India) in a particular sector may be rising or
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declining during the period of the study. The same can happen to
WMS of other countries creating a two-by-two matrix with four
possible outcomes. Further, in cases where the market shares of
the reference country (India) and other countries are moving in
the same direction it provides more possible outcomes where com-
parative movement may point to relative competitive strength or
weakness (see Table 11.5).

Table 11.5: Matrix of Competitive Interactions between India and Other

Countries in the Study

India’s World Market Share

Rising Falling
A.1 Other Country is Partially B. Other Country is
Competitive than India More Competitive
Both India and Other country No threat from India to
have rising market share where other country but the
other country is gaining more other country would
than India. threaten India.
Rising
A.2 India is Partially Competi-
Other tive than Other Country
Country’s Both India and Other coun-
World try have rising market share
Market where India is gaining more
Share than other country.
C. India is More Competitive D. Mutual Withdrawal:
India gets market share and No one is Competi-
other country looses it. This tive
Falling may indicate causal relation- Both parties lose mar-
ship unless other country is ket share in exports to
loosing market share even in other competitors.
absence of India.
Source: Based on Lall, S. and N. Albaladejo. 2004. ‘China’s Competitive Performance: A Threat
to East Asian Manufacutred Exports’, World Development, 32(9): 1441–466; Lall, S. and J.
Weiss. 2005. ‘China’s Competitive Threat to Latin America: An Analysis for 1990–2002’, Oxford
Development Studies, 33(2): 163–94.
 Changing Pattern of Country Competitiveness •2 7 5

In this regard the WMS of each country in the study in

respective services categories is calculated for the year 2000 and
2008 and the difference between the two years is calculated to
observe change in WMS for each country during that period. This
is presented in Table 11.6.
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Table 11.6: Change in World Market Share of Countries in CIS during 2000–2008

WMS
Country 2000 2008 Change
Chile 0.0779 0.0474 0.0305
China 0.8301 3.0880 2.2579
France 1.8769 0.9142 0.9628
Germany 8.8371 7.6347 1.2024
India 14.7861 24.2190 9.4329
Ireland 12.8101 17.3920 4.5819
Malaysia 0.1912 0.5092 0.3180
Netherlands 2.7016 3.3282 0.6266
Philippines 0.1772 0.1976 0.0204
Spain 4.7697 3.0405 1.7292
UK 10.0956 6.6395 3.4560
US 13.0721 6.6136 6.4585
Source: Author’s calculation.

From the table it can be observed that different countries

in the study are quite dissimilar in terms of their market share in
each service category. They have also shown varying performance
in terms of gaining and losing market share during the period of
the study. It can be seen from the table that India has demonstrated
superior performance in trade in services during the period of the
study and increased its WMS in each category of services under
this study.
Using WMS data for different countries in business services
presented in Table 11.6 and the matrix of competitive interaction
in Table 11.5, competitive mapping of different countries is done
to identify relative competitiveness of different countries in the
study. Table 11.7 has revealed that India has been performing well
 276•Jayesh N. Desai

Table 11.7: Mapping India and Different Countries in the Study for Competitive
Performance during 2000–2008

India’s World Market Share in CIS

Rising Falling
A.1 Other Country is B. Other Country
Partially Competitive is More Competi-
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than India tive

A.2 India is Partially
Rising
Competitive than Other
Competitive
Other Country’s
World Market China, Ireland, Malaysia,
Share in CIS Netherlands, Philippines
C. India is more Com- D. Mutual With-
petitive drawal : No one
Falling is Competitive
Chile, France, Germany,
Indonesia, Spain, UK, US
Source: Author’s calculation.

in CIS. In this category India’s gain in WMS was highest at 9.43

per cent amongst the countries in the study. Other countries which
have also experienced gain in their WMS in CIS are China, Ireland,
Malaysia, the Netherlands, and the Philippines. However, their
gain in WMS in CIS is much less than that of India. The countries
which lost their market share during the same period and faced a
competitive threat from India are Chile, France, Germany, Spain,
UK, and US. India clearly enjoys a competitive advantage in this
category of service trade over them.

Relative Movements in World Market Share,

Export Growth Rates and Size of Exports in CIS
amongst Countries in the Study
In the previous section, to check the competitiveness of countries
in the study, only their WMS was used. In this section, to further
probe a country’s performance in trade in business services, their
mapping is done on three dimensions representing the countries’
relative performances. Out of three dimensions, two are dynamic
 Changing Pattern of Country Competitiveness •2 7 7

measures and one is a static measure of performance of the country

in the sector. To capture the dynamic aspect of performance,
change in WMS and export growth rates during the period of study
are used and as a static measure the country’s total size of exports
in the sector at the end of the period of study is used.
In order to understand the performance of different
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countries in CIS, a bubble diagram is used to map the relative

performance of countries in the study (see Figure 11.3).

Figure 11.3: Change in WMS and Export Growth Rate and Total Exports in CIS

45
CAGR in CIS exports during 2000–2008

China (36.3, 6)
40

35
Philippines (29.3, 0.4) Malaysia (29.2, 1)
30
Netherland (26.2, 6.6)
India (26.6, 4.9)
25
Germany (16.3, 15)
20
UK (16, 12.9) Ireland (21.2, 34)
15
Spain (13.7, 6)
10 Chile (10.9, 0.95)
France (10.1, 1.5)
US (9, 13) 5

0
⫺10.0000 ⫺5.0000 0.0000 5.0000 10.0000 15.0000

Change in world market share in CIS during 2000–2008

Source: Based on author’s calculation of data taken from UNSD database available at http://
[Link]/unsd/servicetrade/ and OECD database at [Link] [Link]
org/[Link]?themetreeid=-200 (accessed 2 May 2011).

As can be seen from Table 11.6, India already had the

highest WMS at 14.78 per cent in 2000, the starting year of this
study. On this high base Indian CIS exports demonstrated the
highest WMS gain of 9.43 per cent to capture the highest WMS
at 24.22 per cent, a fourth of total international trade in CIS so
India has emerged as the clear market leader in trade in CIS in the
world market. It has also indicated that there is no direct or partial
competitive threat from any country to India in the category.
Ireland, which stood second in terms of gain in WMS in CIS, was
a distant performer with gains in market share of 5.59 per cent
which was almost half the gain of India. Three countries performed
 278•Jayesh N. Desai

better than India in terms of growth rate of exports in CIS. These

countries were China (36.3 per cent CAGR), the Philippines (29.3
per cent CAGR) and Malaysia (29.2 per cent CAGR). However,
their size of exports is significantly smaller as compared to the big
two, India and Ireland. Countries that lost more than 1 per cent
WMS during the period of the study are Germany, UK, Spain, and
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US. Amongst these countries, US lost the highest at 6.45 per cent in
WMS demonstrating clear comparative disadvantage in the sector.

Conclusion
Developments in ICT have facilitated international trade in
services. Cross-border trade in services was once considered
difficult, yet it is increasingly taking place today with the help
of ICT. It is also changing the profile of participants in trade in
services. Today in trade in CIS, developed and developing countries
both have emerged as leading participants in international trade.
In CIS, India and Ireland have emerged as the most competitive
countries. During the entire period of the study, especially India has
demonstrated outstanding performance in trade in CIS. It has also
gained an exceptionally high comparative advantage in this trade.
Further, countries like China, Malaysia, the Philippines, though
at a smaller level, indicated signs of improving competitiveness,
whereas the trade performance of conventionally important players
of trade in services like the US, UK, Germany, Spain, and France
point to deteriorating competitive position. Therefore, trade in CIS
indicates a shifting pattern of country competitiveness in trade in
services.

Notes
1. Here business services refer to total services minus travel, trans-
portation and government services not included elsewhere (GNIE).
Alternatively in this research, ‘business services’ refers to CIS, and
miscellaneous business, professional and technical services (Misc BPT
services) included in UN Services Database classification.
 Changing Pattern of Country Competitiveness •2 7 9

2. In the selection of countries in this study based on size of trade in to-

tal services, the use of CIS and other business services of ‘top thirteen
countries’ as a criteria for selecting countries is somewhat arbitrary.
3. In UNSD classification Misc BPT services is a sub-category (Lall and
Albaladejo, 2004; Lall and Weiss, 2005).
4. Here trade in services classification is based on the services classifica-
tion used by the UN Database in Services.
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References
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———. 2007. Offshoring for Long-Term Advantage: The 2007 A. T. Kearney
Global Services Location Index, Illinois: A. T. Kearney.
———. 2009. The Shifting Geography of Offshoring: The 2009 A. T. Kearney
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———. 1977. ‘Revealed Comparative Advantage Revisited: An Analysis of
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Chaudhuri, S. and S. Ray. 1997. ‘The Competitiveness Conundrum: Lit-
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D’Cruz, J. and A. Rugman. 1992. New Concepts for Canadian Competitive-
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 280•Jayesh N. Desai

Deardorff, A. V. 1985. ‘Comparative Advantage and International Trade

and Investment in Services’, in R. M. Stern (ed.), Trade and Investment
in Services: Canada/US Perspectives, Toronto: Ontario Economic Council,
pp. 39–71.
Deardorff, A. V. and R. M. Stern. 2004. ‘Empirical Analysis of Barriers
to International Services Transactions and the Consequences of
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Paper 505. Ann Arbor, MI: University of Michigan School of Public Policy.
Desai, J. N. and K. Pandya. 2007. ‘Outsourcing of Services: A New Growth
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Interdisciplinary Studies in Social Sciences, Veer Narmad South Gujarat
University, Working Paper No. 2.
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Wider Research Paper No. 2008/11, Norwich.
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in Economic Growth’, in F. G. Adams and B. Hickman (eds), Global
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 12
Optimal Pricing Policy of
Kolkata–Agartala Transit Route:
Some Methodological Issues
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Subir Kumar Sen, Sudakshina Gupta and

Ishita Mukhopadhyay

B
efore partition, Tripura was very much connected with
India’s hinterland both by roads and railways through the
then East Bengal (presently known as Bangladesh).1 So, no
need was felt to connect Tripura with the rest of the states in the
northeast.2 But the partition made Tripura an extreme outpost not
only from the heartland of India but also from the northeastern
region. After partition, Tripura emerged as a mirror image of the
whole northeastern region since partition converted the latter to
a chicken-shaped area connected with the mainland through the
congested Siliguri corridor whereas the former was converted
into a landlocked region feasibly connected with the northeastern
region only through the narrow Churaibari corridor. Though it
shared some boundary with neighbouring Mizoram in the eastern
part smooth transportation was not possible due to the presence
of the Jampui Hills on the Mizoram state border. The remaining
boundary is covered by Bangladesh in the whole western, southern
and most of the eastern side. Hence, the immediate need was to
connect Tripura with the northeastern region. The Assam–Agartala
road (National Highway-44) project via Churaibari was found to
be the only economically viable project. The central government
constructed the Assam–Agartala road through the hilly region.
As a result, a well-connected native state became an isolated
landlocked region with its immense geo-strategic importance in the
face of political tension between India and Pakistan. Against this
background, Tripura is constantly facing the problem of a lack of
smooth transportation and naturally, it is an economic imperative
for this landlocked state to seek benefits for itself through greater
regional integration. The development of the state requires the
existence of a viable road network in Tripura so that the transport
 282•Subir Kumar Sen, Sudakshina Gupta and Ishita Mukhopadhyay

cost for both inflows and outflows of commodities from Tripura

will be cheaper. The state government of Tripura is continuously
demanding for a transit route through Bangladesh but they are not
ready to implement this because of possible threat of loss. So, the
debate on the possibility of a viable road network is still relevant
for the economic progress of the state.
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However, it is a fact that the Asian highway project has

not directly covered three states of the northeastern region —
Tripura is one of them. But the existing roadway link, if improved,
may connect the previously unconnected states of the northeast-
ern region including Tripura with the proposed Asian Highway
Network and accelerate its border trade with countries like China.
Moreover, the Asian highway project may be used more effectively
if the demand of Tripura for using the sea port in Bangladesh is
granted. The entire trade situation is likely to be changed as a
result. Tripura is likely to be the gateway for transborder trade not
only for India but also for Bangladesh.
The area of research which is proposed here is basically an
attempt to explore the possibilities of a viable road network which
can respond to the demand for communication by the people of
Tripura as well as the demand of Tripura’s projected economy. It
requires no mention that Tripura is geographically a sequester land
located at the remotest corner of the country where transportation
is a relatively time-consuming phenomenon. The northeastern
region is connected by land with the rest of India through West
Bengal. The surface transport system for the movement of cargo/
passengers to and from the northeastern states consists of road, rail
and waterways. As far as cargo movement is concerned, most of the
cargo originates from Kolkata (port) and terminates at Guwahati
and vice-versa. From Guwahati, the cargo gets distributed to
various destinations of the northeast. The transport links to states,
particularly Mizoram, Tripura, Manipur, and Nagaland are many
a time affected by floods, landslides, blockages of roads, and local
agitations. Apart from that, the stretches and curves of roads in
the hilly area do not permit smooth and feasible cargo services
in this region. Perhaps, the best example is the natural gas-based
Palatana power plant which is yet to be established as the present
road network within Tripura is not capable of carrying the required
machinery for that project.3 The Government of India was seeking
permission from the Bangladesh government to allow their roads
 Optimal Pricing Policy of Kolkata–Agartala Transit Route •2 8 3

for this purpose. Ultimately, in December 2010, a Memorandum of

Understanding has been signed between India and Bangladesh to
tranship the required heavy machinery through the sea and land
route of the latter in a phased manner.
The main objective of this chapter is to investigate the
pricing policy of a transit route for India to move cargo through
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Bangladesh from Kolkata port to the capital city of Tripura, that is,
Agartala, keeping in mind the advantage and disadvantage of the
existing road network in Tripura as well as the future opening of
the Myanmar route as an alternative transit route via the Mizoram
state border for the northeastern region in general and Tripura, in
particular. As such, no such significant work has been found with
particular reference to this type of problem for a less developed and
geographically sequester state like Tripura in the Indian context. It
is hoped that this study will fill that gap.

Review of Literature
A study of the available literature suggests that the effect of
transportation investment on economic development comes from
the role of transportation facilities in enabling movement and
interchange of activities between different locations. The earliest
works in regional science recognised that both the growth and
concentration of economic activity at any given location depends
largely on access to markets and the location economies arising
out of that access. This is reflected in the works of Marshall (1919)
who explained the need for transportation for enhancing economic
growth in terms of economies of scale of production whereas Weber
(1929) tried to explain this interface in the line of Marshall through
the concept of agglomeration of different stages of production.
On the other hand, the central place development theory was
propounded by Christaller (1933). Recently, Weisbrod (2007)
explained this in terms of a business decision-making perspective
and identified the mechanisms whereby transportation can affect
supplier and buyer markets and costs, affecting the pattern and
magnitude of economic growth among various industries and
locations. Further, the economic development of any society is
a complex process which depends on several interacting forces.
Perhaps one of the most important of these forces is the provision
 284•Subir Kumar Sen, Sudakshina Gupta and Ishita Mukhopadhyay

of adequate transport infrastructures. This is particularly true in the

largely subsistence economy of most Asian and African countries
where transport constitutes the key to development, especially
at the early stages of economic advance. Stuckey (1973) argued
that transport facilitated economic advancement and transport
improvement was indeed part of the economic advancement.
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A certain percentage of the economic activities arose directly

because of new transport possibilities but for the most part, new
transport facilities enabled the expansion of local activity and
the integration of previously isolated markets. In the same line,
Filani (1978) observed that the socio-economic development of
any society depends to a large extent on the nature and structure
of the transportation network of the society. He also argued that
transportation provides the arteries through which the economic
life-stream of society flows — the people, information, raw
materials, and finished products which help to build and maintain
the society. However, no society can exist above the subsistence
level without a measure of improvement in its transport system.
In a review of the Urban Transport Strategy of the World
Bank (2001b), Venter et al. (2003) and Maunder et al. (2004)
recognise the need to more systematically address access issues,
especially for those who are mobility impaired. This is particularly
the case for most of the landlocked countries that do not have
any sea coast.4 As a result, in order to trade with the rest of the
world, these countries must depend on their neighbours for transit
to reach the sea.
Arvis et al. (2007) have pointed out that at present,
about one out of five countries in the world is landlocked. The
problem mostly affects the poorest countries: 20 out of 54 low-
income economies are landlocked, with a majority of them in
Sub-Saharan Africa, while only three high-income economies out
of 35 are landlocked. Arvis et al., further pointed out that nine
of the 12 countries ranked lowest on the 2002 Human Develop-
ment Index are landlocked referring to a parcel of real property
which has no access or egress (entry or exit) to a public street and
cannot be reached except by crossing another’s property. Although
landlocked developing countries (LLDC) are developing countries
that are landlocked. The economic and other disadvantages expe-
rienced by such countries tends to place them amongst the least
developed countries (LDC) in the world, represent 12.5 per cent
 Optimal Pricing Policy of Kolkata–Agartala Transit Route •2 8 5

of the world’s land area and 4 per cent of the global population,
their combined gross domestic product accounts for only 0.3 per
cent of the total. Without direct access to the oceans, these coun-
tries must pay on an average of 15 per cent of export earnings on
transport; for some African countries it is as high as 50 per cent.
Other developing countries spend only 7 per cent on such services
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and developed countries 4 per cent. The case of landlocked devel-

oping countries has naturally received special attention, including
a specific set of development priorities which was reflected in the
Almaty Conference (2003).
Variants of the new economic geography, new trade
theory, neoclassical and endogenous growth theories have been
applied to highlight the nexus between geographic location, trade
and economic growth. Amjadi and Yeats (1995) point out that the
incidence of transport costs falls heavily on the landlocked African
countries since they have to adjust their selling price to world prices.
Bloom and Williamson (1998) highlighted that the landlocked
countries always experienced a weaker growth as compared to the
other maritime developing countries. According to their estimates,
sometimes it is reduced by 1.5 per cent points as compared to the
latter which again was supported by the study of MacKellar et
al. (2002). Therefore, landlockedness can be thought as raising
import prices and reducing export revenues. It is one reason why
Radelet and Sachs (1998) advocate the idea that a re-export model
is extremely difficult to achieve in landlocked developing countries
due to the higher cost of intermediate products. Gallup et al.
(1999) identified two reasons behind the disadvantaged position
of landlocked countries which may be stated as (a) Coastal
countries may have military or economic incentives to impose
costs on landlocked countries; and (b) Infrastructure development
across national borders is more difficult to arrange than similar
investments within a country.
Limao and Venables (2001) estimate that the landlocked
countries trade on average 30 per cent less than coastal countries.
In this context, MacKellar et al. (2002) explain the negative rela-
tionship between landlockedness and growth using a neoclassical
theory. They highlight that crossing a border implies higher trans-
action costs due to customs and handling costs.
Dependence over the transit state necessarily implies high
transaction costs (notably transportation costs). In this regard,
 286•Subir Kumar Sen, Sudakshina Gupta and Ishita Mukhopadhyay

UNCTAD (2002) identified the ‘transit charges’ like port charges,

road tolls, forwarding fees, customs bonds, or transport quota
restrictions. Hence, the impact of being landlocked is based on
the idea of dependence over the transit state. It has produced two
main corollaries: either high transaction costs for the landlocked
countries due to their dependence for transit and/or the fact
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that they are bound to accept the rules of transit for landlocked
countries by the transit-providing countries.
While there is a consensus on the problems of landlocked
countries, the analysis so far has mainly focussed on their transport
cost disadvantage. Transport costs, however, account for only part
of the real cost of being landlocked as they do not account for the
transit delays and unpredictability which are critical in international
trade. In the literature, macro-data are usually used to estimate
the transportation costs burden. Radelet and Sachs (1998) find
these costs to be about 50 per cent higher for landlocked countries.
Stone (2001), using the ratio of ‘freight payments as percent of
total imports’, shows that landlocked developing countries,
especially in Africa, bear exorbitant transport costs: out of 15
landlocked African countries, 13 had a ratio higher than 10 per
cent and for seven the ratio was even higher at 20 per cent as
compared with 4.7 per cent for industrial countries and 2.2 per
cent for the US. However, Arvis et al. (2007) questioned the notion
that costs of transportation supported by developing countries are
intrinsically high. Neither the distance covered, nor the unit cost of
transportation services are necessarily much higher in landlocked
developing countries than in the wealthiest countries. Yet there are
significant variations; for instance, Central and East Africa have
higher unit costs than the EU but this is not the case of South and
East Asia or other sub-regions in Africa. Furthermore, transportation
costs only explain one part of the real impact of being landlocked.
Delays, and even more importantly, a low degree of reliability and
predictability of services create massive disincentives to invest and
higher total logistics costs. Moreover, Arvis et al. demonstrated in
that study that the gap between landlocked countries and gateway
countries may not be very high — if transport cost is the only
parameter taken into account. Shippers in most African gateway
countries already face high logistics costs when adding maritime
transport, port charges (which can be 10 times higher in some
African ports as compared to ports in developed countries), and
 Optimal Pricing Policy of Kolkata–Agartala Transit Route •2 8 7

domestic transport (especially to/from remote areas, as is the case

for several export crops). In Africa, many shippers in landlocked
developing countries have the same charges to move goods from/
to ports as shippers in the gateway country.
In order to remove the disparity of transportation facility
among the member countries, particularly for the landlocked
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developing countries, Article V of the GATT 1994 (Freedom of Transit)

provides for the freedom of transit of goods, vessels and other means
of transport across the territory of WTO members via the routes most
convenient for international transit, without distinguishing between
flag of vessel, origin, departure, entry, exit, destination, or ownership
of the goods, vessels or other means of transport involved.
Freedom of transit and a viable customs transit regime for
international transit are both particularly important for landlocked
developing countries, many of which are among the poorest of the
developing countries with the weakest growth rates, and typically
dependent on commodity exports or imports of intermediate
goods. In this context, the Almaty Conference in August 2003 drew
attention to the problem of transit for these countries and devised
an action programme. Customs transit regimes usually tend to
suffer from the same shortcomings as other customs transactions.
These include the lack of simplified and standardised customs
procedures, documents and data processing, publication of fees
and charges, cooperation among national customs authorities,
adequate security measures to combat fraud and smuggling,
risk management techniques, computerisation and electronic
messaging. Inadequate transport infrastructure, logistics, vehicle
standards, and container seals add to these problems.
However, to confirm smooth transportation from the gateway
country to the landlocked one, transhipment instead of transit is
a better alternative in reducing the extent of custom procedure as
well as related data work. Transhipment refers to the same inter-
country passage using gateway country-owned transportation,
whereas in transit, landlocked country-owned surface transport
move through the transit from one end to the other. For example,
Germany or Austria sends goods to Italy through Switzerland.
Another instance of transit is Alaska dispatching goods to main-
land US through Canada.
While the basic obligations in Article V aim at ensuring
optimal conditions for transit, there are indications that, on the
 288•Subir Kumar Sen, Sudakshina Gupta and Ishita Mukhopadhyay

ground, real freedom of transit is often absent or compromised. The

conditions of international trade and the requirements for transit
have changed since Article V was originally formulated in the late
1940s, and comments from business, international organisations
and WTO members, in particular developing ones, have suggested
a number of obstacles and shortcomings in relation to transit.
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This study shall attempt to enrich the existing literature

by considering the pricing policy of a transit route for landlocked
developing countries particularly for those counties which have
more than one feasible transit gateway through the neighbouring
countries.

India–Bangladesh Relations and the Issue of

Transit/Transhipments Route for the
Northeastern Region
As mentioned earlier, partition makes the whole of northeastern
India a partially landlocked region. In a real sense, it cannot be
defined as a landlocked region. However, the chicken neck shaped
geographic location coupled with the presence of hilly terrain across
the region makes this a partially isolated region from its heartland.
A tiny hill state like Tripura always lies below the national growth
rate of state domestic product. There may be several reasons
behind this underdevelopment but, undoubtedly, lack of proper
communication with the rest of the country as well as with the
neighbouring northeastern states aggravates the problem. This
may be identified as a pseudo-landlocked region where, being a
part of the Indian territory, this particular state is not landlocked
in the true sense but the feasible road distance from the nearest
sea port, that is, Kolkata port, is more than four times the arial
distance from the same, ultimately making this state economically
landlocked.
Against this backdrop, the state government of Tripura
is continuously demanding the transit route through Bangladesh
for inflow and outflow of commodities from its heartland but
Bangladesh was not ready to do this because of possible threat of
loss. Apart from this a debate has been raging in Bangladesh on
whether transit facilities should be given to India or not through
the land territory of Bangladesh. This debate is more political in
 Optimal Pricing Policy of Kolkata–Agartala Transit Route •2 8 9

nature than that of pure economic logic. Some argue that what
India is demanding is some kind of rights on the territory of
Bangladesh to move goods and people from the western part of
India to its landlocked northeastern region and hence, they try to
solve some of the core bilateral issues with India before giving this
type of facility. The other groups are advocating this transit issue
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as an economic issue for trade facilitation and that it should not be

politicised. Whatever be the view, it is a fact that the transit issue
is a complex one and a multi-faceted issue. The ambiguity arises
due to two concepts: corridor versus transit. In the corridor aspect,
a country gives some kind of rights or control on the land to the
other country making it a de facto part of its territory, while in
transit there is no question of rights involved in the land territory
allowed for transit. It provides only transit facilities under certain
conditions and can be withdrawn. On the other hand, transit is
an inter-country passage (like waterway-transit already provided
to India since 1972), where India wants to dispatch goods and
other materials from western parts of India to its seven landlocked
northeastern states through Bangladesh and no kind of rights exist
on the land territory of Bangladesh.

Bilateral vis-à-vis Continental Transit Issues

Geographically, Bangladesh has some natural monopoly in this
particular issue. Now the question is why Bangladesh was reluctant
to permit such facilities to India. Being the natural monopolist in
this particular issue, it tried to solve some basic bilateral issues
with India. Two major bilateral issues can be identified in this
case. First, it wants similar transit facilities from India to access
Nepal and Bhutan. These landlocked Himalayan countries are
geographically quite close to Bangladesh but they are surrounded
by India. Nepal and Bangladesh are separated by a narrow piece of
Indian territory of about 15 kilometres in the southeast. Had there
been transit facilities (Nepal–India–Bangladesh), landlocked Nepal
(and Bhutan) could use Chittagong and Mongla port of Bangladesh
that could cut down its transportation cost dramatically and one
could see better trade and tourism relations between these two
countries. Second, Bangladesh’s export to India accounts for less
than 7 per cent of its total imports from the latter. As a result, it
has a massive trade deficit with India. Moreover, large volumes
 290•Subir Kumar Sen, Sudakshina Gupta and Ishita Mukhopadhyay

of informal imports from India cross the land border avoiding

Bangladesh import duties. There are allegations from Bangladesh
that its products often face India’s non-tariff barriers and other
bureaucratic hurdles. But the Trade Complementarity Index shows
that trade complementarity between Bangladesh and India is
very low (5.42). This is due to less diversified export basket of
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Bangladesh for India as well as the fact that the latter country
is highly concentrated on readymade garment products which are
not a significant import item for India. On the other hand, India
has a broad export basket and close geographical proximity which,
in turn, has helped Bangladesh to source for many commodities
and final products with comparatively cheaper price. Hence, until
and unless these complementarity issues are overcome, it is hardly
possible for Bangladesh to redress such imbalances. In recent years,
trade barriers have declined, both in Bangladesh and India, in
line with their commitments to the World Trade Organisation and
South Asian Preferential Trade Arrangement (SAPTA). Moreover,
India has given preferences to Bangladesh on approximately 2,925
tariff lines under SAPTA. However, these two bilateral issues have
already been solved through a bilateral treaty between them.
From this analysis, it seems that Bangladesh was not fully
reluctant to allow India to use its territory to access northeast India
but what it wants is a continental transit facility, especially in the
southern part of the SAARC region (Bangladesh–India–Nepal–
Bhutan) which does make more economic sense. There is an
overwhelming consensus that, to integrate South Asia with South
East and other parts of Asia, there is a need for a greater transport
network across Asia. But India and Bangladesh have significant
differences on the selection of the Asian Highway Network (AHN).
Bangladesh opposes the proposed route (India–Bangladesh portion)
that enters into Bangladesh from India and again, goes back into
India. Bangladesh wants to initiate a route that connects it with
South East Asia as well going through Chittagong and Myanmar,
as the proposed route, as it argues, will virtually become a transit
route for Indian goods between the rest of India and northeast
India. For this, Islam (2008) commented that Bangladesh always
tried to maintain this natural monopoly situation in order to solve
all its bilateral issues with India in a single package. Indeed,
this is one of the reasons why the tripartite gas pipeline project
(Myanmar–Bangladesh–India) had not implemented finally.
 Optimal Pricing Policy of Kolkata–Agartala Transit Route •2 9 1

Here, Bangladesh is always contemplating the tranship-

ment/transit issues with Nepal and Bhutan but Myanmar was not
ready to accept the proposed AHN route through Myanmar–Bang-
ladesh–India route rather they are more interested to propose this
route in Myanmar–Northeastern India–Bangladesh–India line.
Once the role of Myanmar is incorporated in this game, the rela-
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tive advantage of Bangladesh will turn into potential disadvantage

when the latter are not ready to provide transit/transhipment facil-
ity for the northeastern region of India. Another major issue in this
context is to determine the pricing of such a transit/transhipment
route. Since the transporter country, India, will utilise the trans-
port infrastructure of Bangladesh, India has to pay the requisite
fees, or in other words, it is a question of how much price can
Bangladesh charge at most to provide such transit/transhipment
facilities through its own territory. To answer these questions, we
consider the following model to determine the optimal pricing of
such a route in the two situations: (i) Bangladesh route is the only
available alternative; and (ii) Myanmar is also interested in pro-
viding transit/transhipment facility to India for its northeastern
region.

Model
When the Myanmar route for transit/transhipment was not
available, the transit/transhipments route through Bangladesh was
the only available alternative to avoid the staggering transport cost
to ship the commodities from the hinterland to its northeastern
parts. Obviously, in the absence of a land transit link between India
and Bangladesh, the traffic between Kolkata and Assam is mainly
carried by rail and road links through the Siliguri corridor and the
requirements of additional transport costs for carrying goods is
staggering. To transport goods to and from the northeast through
the corridor, the Indian government provides 25 per cent transport
subsidy. It is estimated that Rs 7 billion are being spent as additional
costs to transport goods and services to and from northeast India.
The figure is estimated in 1990s and it is expected that the cost has
increased in tandem with economic growth both in northeast India
and the rest of India. As such, a transit route through Bangladesh
can integrate northeast India with its mainland and is set to reduce
 292•Subir Kumar Sen, Sudakshina Gupta and Ishita Mukhopadhyay

transportation cost significantly. In order to alleviate this problem

effectively, evaluation studies must be performed in order to invest
limited resources for maximum social benefits.

Assumptions
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Four fundamental assumptions are made in this model:

(1) Here, the transhipment route itself is treated as tradable
commodity;
(2) The amount of transhipment is measured in terms of total
amount of cargo movement from Kolkata port to Agartala
during that period;
(3) The transit/transhipment providing countries are non-
cooperative in nature; and
(4) All cargo may not be homogeneous.
The last assumption needs to be explained in detail. Apart
from providing a transit route through their own territory, both the
gateway countries have some export basket for India. Hence, any
cargo containing readymade garments originating from Kolkata
port towards Agartala can hardly get any passage through Bang-
ladesh because this item is one of the most important exportable
items for Bangladesh. But the same cargo can easily reach Agartala
through the Myanmar route. Similarly, any cargo containing rice
can hardly expect to get passage through Myanmar though it can
reach Agartala via Bangladesh. In this sense, it is assumed that all
cargos are not homogeneous.

Notations
tjI: Actual average transportation cost per unit from Kolkata port
to Guwahati at par with the all-India level;
tjB: Average transportation cost per unit from Kolkata port to
Agartala via the Bangladesh route;
tjM: Average transportation cost per unit from Kolkata port to
Agartala via the Myanmar route; and
tjA: Actual average transportation cost per unit from Guwahati to
Agartala via the existing route; the total unit of cargo to be
transhipped.
 Optimal Pricing Policy of Kolkata–Agartala Transit Route •2 9 3

Further, we assume that (tjB, tjM) < (tjAtjI). Otherwise, the

issue of transit or transhipment through the neighbouring counties
will not arise.
But, tjB><tjM
It may be noted that the normal transportation cost is
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assumed to be included in the cost schedule in contemporary

economic literature. Hence, if the producer operates under break-
even situation then they hardly find any inducement to sell their
products beyond the Guwahati market due to this extra cost burden
above its normal level. Simply due to this adverse geographical
location problem, the transport subsidy for this region is staggering.
If Ti is total transportation cost to Agartala from Kolkata
port via ith route; for all i  I, B and M, accordingly, the total
transhipment costs to Agartala through the alternative routes are
as following:
TA  n
j1
(tjA  tjI).Xj  0 > 0 (1)
TB  n
j1
[Link]> 0 (2)
TM  n
j1
[Link]> 0 (3)

From where, assuming TA is the upper limit of total transport

cost to Agartala from Kolkata port through the conventional route,
the net gains from providing transhipment facility to Agartala may
be written as:
Net gains for Bangladesh  TA  TB  nj1(tjA  tjI  tjB).xj (4)
Net gains for Myanmar  T  T  j1(tjA  tjI  tjM).xj
A M n
(5)
The right hand sides show the individual net actual gains
beyond its normal level from providing transhipment facility to
Agartala by the country through which the transhipment takes
place.
Hence, tjB><tjMœ nj1(tjA  tjI  tjB).Xj <  > nj1(tjA  tj 
tjM).Xj (6)
Moreover, it may be noted that from equations (1) and (4),
TA  nj1(tjA  tjI).Xj
Or, TA  nj1(tjA  tjI  tjB  tjB).Xj
Or, TA  nj[Link]  nj1(tjI  tjB).xj  nj[Link] (7)
 294•Subir Kumar Sen, Sudakshina Gupta and Ishita Mukhopadhyay

Similarly, from equations (1) and (5),

TA  n
[Link] 
j1
n
(tjI  tjM).xj 
j1
n
[Link]
j1
(8)
i.e.,
[Actual cost of Transhipments
Though Foreign Country]  [Net
[Actual Transportation
 Loss Due to Intra Regional Strategic
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Cost to Agartala]
Disadvantage] [Net Loss Due to Inter
Regional Strategic Disadvantage]

Case1: Bangladesh Alone Provides

Transhipments Facility for Agartala
The demand function for cargo through the Bangladesh transit
route may be considered as:
tjB  B  [Link] (9)
where B>0 is the intercept and b>0 is the slope coefficient of
the demand function thereby confirming the negatively sloped
demand curve.
The cost structure may be considered as: CB Fb [Link] (10)
where again, F>o denotes the fixed cost and C denotes the
marginal cost
BC1
Hence, under monopoly situation, Xj* ______ (11a)
2b
Accordingly, tjB*  B  [Link]* (11b)
Hence, equilibrium may be achieved by equating equations (7)
and equation (8),

Case 2: Transit through Myanmar is also Possible

(Case of Differentiated Bertrand Competition)
We retain the same demand function. Hence the demand function
appears to be:
For Bangladesh: tjB  A1  [Link]  [Link] (12a)
For Myanmar: tjB  A2  [Link]  [Link] (12b)
where (A1,A2)>0 are the intercepts terms and a1,a2.b1,b2>0 are
the slope coefficients of the demand functions thereby confirming
the negatively sloped demand curves for each country.
 Optimal Pricing Policy of Kolkata–Agartala Transit Route •2 9 5

Accordingly, the cost functions may be assumed as:

For Bangladesh: CB Fb  C1 (13a)
For Myanmar: CM Fm  C2 (13b)
Similarly, where again, F>o denotes the fixed cost and C denotes
the marginal cost, respectively, for each country.
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Under non-cooperative type situation, the optimal amount

of transhipment through different routes is found to be as following:
2(A1C1)a2  (A2C2)b2
tjB** _________________________
4a1a2b1b2
and 2(A2  C2)a1  (A1  C1)b1
tjM** ___________________________ (14)
4a1a2  b1b2
From these, we can calculate, XjB**and XjM** (15)
From this analysis, it is clear that a transit/transhipment
facility cannot solve the whole transport disadvantage for India.
But, under continental transhipment, India can substantially
reduce its inter-regional disadvantage and there is a possibility
that the intra-regional loss will also reduce from its present level.
Transhipment alone cannot solve the staggering transportation cost
burden but undoubtedly, the extent will reduce from its present
level. Simultaneously, the transhipment-providing countries like
Bangladesh and Myanmar will gain significantly in terms of derived
demand of transport infrastructure and allied sectors. Further, this
continental transport network can lead towards an integrated
transport network for this region.

Conclusion
Though Bangladesh is suffering from a mounted trade deficit with
India, a close look towards its deficit component clearly shows that
it is a net importer in multiple dimensions so far as the western
side is considered. At the same time, it is a net exporter to India if
its trade statistics are considered; it enjoys trade surplus with the
northeastern region. Due to this strategic advantage, Bangladesh
has some specific interest for trade with this region. Initially,
Bangladesh was hesitating to allow India to provide transhipment
facility for the northeastern region but India reciprocated it in
 296•Subir Kumar Sen, Sudakshina Gupta and Ishita Mukhopadhyay

the right direction by providing a similar transit facility to reach

the Himalayan landlocked countries like Nepal and Bhutan,
thereby, actively participating in moving towards an integrated
transport network for this region as a whole. The opening of
the Myanmar route further gives India some relief in terms of
reduced transportation cost due to both inter- and intra-regional
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disadvantage for a landlocked state like Tripura.

Notes
1. On 15 August 1947 India got independence and bifurcated as India
and Pakistan. At that time, Tripura was a princely state and formally
integrated with India on 15 October 1949.
2. The northeastern region comprises seven states, viz., Assam, Arunachal
Pradesh, Meghalaya, Manipur, Mizoram, Nagaland, and Tripura
(known as the Seven Sisters). Recently, Sikkim has also been incorpo-
rated into this region.
3. Palatana Power Project is situated near Udaipur, the district head-
quarters of South Tripura, approximately 60 km away from Agartala,
the capital city of Tripura.
4. Actually, there are 42 landlocked countries in the world today. Except
for the relatively wealthy landlocked states in Western and Central
Europe (for example, Switzerland, Austria, the Czech Republic,
Hungary, and Slovakia), the rest are all poor and 31 landlocked
countries can accurately be classified as LLDCs. Sixteen of the LLDCs
are also categorised as least developed countries (LDCs). In the SAARC
region, there are three LLDCs: Afghanistan, Nepal and Bhutan.

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Section III

Value Chains and Production Networks

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 13
Integration of the Indian Machinery Sector
into Global Production Networks
Neha Gupta
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A
lthough ‘global production networks’ (GPNs) is an old
concept, it is receiving bigger attention in recent times and
is known by different terms, namely, global commodity
chains (GCCs), global value chains (GVCs), global supply chains
(GSCs), global production sharing, fragmentation, or the like.
Trade is now looked upon in a different perspective, which is not
limited to finished goods only, but is getting inclined more towards
intermediate goods. Several firms located in varied locations of
the world are undertaking different sets of activities involved in
designing, production, marketing, and distribution of products.
Intra-industry trade (IIT) is taking place where a country simul-
taneously exports and imports goods within the same product
category. The most prominent and well-established GPNs are
observed in the machinery sector of East Asian countries. World-
wide, researchers are studying them with great interest, focussing
mainly on their advantageous features. For instance, producers of
developing countries/LDCs need not undertake all the production
processes indigenously; they can concentrate on simple tasks in
which they have an edge, while leaving the rest of the activities
at the consideration of lead firms of chains (Nathan, 2010). These
lead firms also help them to acquire production capabilities fast
by instilling appropriate learning experience and pressure for cost
reduction, quality enhancement, etc. (Humphrey and Schmitz,
2001).
However, the kind of work which is desirable for Indian
industries is still at a nascent stage. Since ages, the machinery
sector has been the backbone of Indian manufacturing and with its
rising importance in the economy it holds immense potential for
further growth.
Here, the machinery sector covers a wide range of industries
on the basis of the Harmonised System product classification (HS
84–92): general machinery (HS 84), electric machinery (HS 85),
 304•Neha Gupta

transport equipment (HS 86–89), and precision machinery (HS

90–92).1 Further, the presence of many parts and components in
this sector requiring a diverse range of technologies, necessitates
their continuous trading within and outside the country.2
Accordingly, the main aim of this study is to find out the
extent of integration of India’s machinery sector into GPNs. The
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questions to be answered include: Is the Indian machinery sector

a part of global supply chains, that is, is it importing intermediate
goods, adding value to them and then further exporting them
either as intermediate or finished goods? Second, is intra-industry
trade rising for the sector? How far have the existing government
policies been successful? Why are East Asian developing countries
more integrated in this sector and what lessons do they give to
India?
This Chapter seeks to provide a base for policy formulation
in the future for the development of potential supply chains in the
machinery sector, in particular reference to a developing country
like India. It suggests that better measures need to be taken by
both the government and concerned industrial associations. The
results clearly show that in spite of witnessing rising trade values
and shares, the participation of India’s machinery sector in GPNs
is not satisfactory.
The first section reviews the literature related to GPNs;
the second section shows India’s role in the world, along with its
development during 1990–2009; the third section briefly discusses
the success story of East Asian countries (mainly, China, Malaysia
and Thailand) and their implications for India; and the last section
concludes the Chapter.

Literature Review
Initial conceptualisation includes the ‘value chain’ of Michael
Porter or ‘production chain’ of Peter Dickens, but an important
concept has come up as ‘global commodity chain (GCC)’ (Gereffi
and Korzeniewicz, 1994).3 Henderson et al. (2002) proposed the
‘global production network (GPN)’ as a ‘conceptual framework
that is capable of grasping the global, regional and local economic
and social dimensions of the processes involved in many (though
by no means all) forms of economic globalization’.4
 Integration of the Indian Machinery Sector into GPNs •3 0 5

Recent international trade literature uses terms like

‘international production network’ (IPN),5 offering a new stream of
thoughts: the fragmentation theory and new economic geography,
with respect to East Asia’s machinery sector.
‘Fragmentation’ was initially propounded by Jones and
Kierzkowski (1990) (as cited in Kimura, 2009) as separation of
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production processes into production blocks (PBs) and relocation

of them to remote places having different locational advantages,
which ultimately reduces total production costs (Figure 13.1).
Production processes vary in terms of technologies, required
factor inputs, etc., which necessitates fragmentation. But, Kimura
and Ando (2005) proposed the theory of two-dimensional
fragmentation (Figure 13.2) to capture the complexities of GPNs
actually developed in East Asian countries.

Figure 13.1: Simple Version of Fragmentation Theory

Before fragmentation

Large integrated factory

After fragmentation
SL
SL PB PB
SL
PB PB
SL SL
PB
PB: Production blocks
SL: Service links

Source: Reproduced from Kimura, Fukunari. 2009. ‘The Spatial Structure of Production/
Distribution Networks and Its Implication for Technology Transfers and Spillovers’, Economic
Research Institute for ASEAN and East Asia Discussion Paper ERIA-DP-2009-02, Jakarta.

In Figure 13.2 the horizontal axis represents fragmentation

in terms of geographical distance between the original and new
position of fragmented PBs (FPBs) and the middle dotted line is
the country’s boundary. The vertical axis represents controllability
of a firm over FPB and the dotted line acts as the firm’s boundary.
Fragmentation takes place only when production cost per se
and service link (SL) costs reduce (Table 13.1). Service link costs in
arm’s length transactions are highly sensitive to geographical distance,
which generates geographical concentration of PBs in order to save
costs. Thus, fragmentation and agglomeration proceed together.
 306•Neha Gupta

Figure 13.2: Two-dimensional Fragmentation Theory

Uncontrollability

Competitive Internet
spot bidding auction
Domestic Cross-border
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arm’s length arm’s length

fragmentation EMS fragmentation

OEM contracts
Subcontracting
Outsourcing

Domestic Cross-border
intra-firm intra-firm
fragmentation fragmentation

Distance
Original position

Source: Reproduced from Kimura, Fukunari and Mitsuyo Ando. 2005. ‘Two-Dimensional
Fragmentation in East Asia: Conceptual Framework and Empirics,’ International Review of
Economics and Finance, 14(3): 317–48.

The ‘new economic geography’ theory suggests that reduc-

tion in trade costs may lead to either more concentration or more
dispersion of economic activities. Negative agglomeration effects
(congestion effects) generate dispersion forces by which some
of the economic activities in industrial agglomeration, typically
labour-intensive activities, start looking for new production sites in
peripheries. These provide opportunities to lagging-behind coun-
tries for inviting PBs, given proper location advantages and reduc-
tion in SL costs (Kimura and Obashi, 2009).
In the Indian context, mostly all studies indicated that
in spite of sound policy framework and schemes being followed
by the Government of India, Indian industries are negligibly
integrated into GPNs (Dimaranan et al., 2009), except for some
industries which have seen an increase in two-way trade, such as,
electrical machinery, iron and steel, etc. (Francis, 2009). India did
not follow production network-driven export growth strategies,
though steady liberalisation of FDI occurred in many sectors.
Tong (2008) highlighted that in India, service trade is
relatively more important than trade in manufactured goods, with
 Integration of the Indian Machinery Sector into GPNs •3 0 7

Table 13.1: Cost Structure in Two-dimensional Fragmentation

Service Link Cost Connecting Production Cost per se in

Production Blocks Production Blocks
Fragmentation Cost due to geographical Cost reduction from location
along the distance elements advantages elements
distance axis (example): transportation (examples): wage level
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telecommunications, access to resources,

inefficiency in distribution. infrastructure service inputs
trade impediments, such s electricity, water
coordination cost and industrial estates,
technological capability.
Fragmentation Transaction cost due to losing Cost reduction from (ids)
along the controllability elements internalization elements
disintegration (example): information (examples): availability of
axis gathering cost on potential various types of potential
business partners, business partners including
monitoring cost, risks on foreign and indigenous firms,
the stability of contracts, development of supporting
immature dispute settlement industry, institutional
mechanism, other deficiency capacity for various type
in legal system and economic of contracts., degree of
institutions incomplete information
Source: Table reproduced from Ando, Mitsuyo and Fukunari Kimura. 2009. ‘Fragmentation in
East Asia: Further Evidence’, Economic Research Institute for ASEAN and East Asia Discussion
Paper ERIA-DP-2009-20, Jakarta.

persistent deficit in trade of the latter. India has limited participation

in Asia’s economic integration and production sharing owing to the
minor role of FDI.
It has been indicated that India remains much less
integrated than China in GPNs, despite the existence of Indian
policies to allow duty-free access to imported components for
use in the production of exports (World Bank 2004) (as cited
in Dimaranan et al., 2009). There have been complaints by
industrialists about administrative complexities and costs involved
in accessing such schemes. The impact of lowering protection or
tariffs and transport costs and implementing well-functioning duty
exemption/drawback systems on the Indian economy is small.
But, machinery and equipment is one segment where India can
increase exports and compete with China. It is found that India will
likely strengthen its ties with global production chains and expand
its trade in manufactured products if duty exemption/drawback
 308•Neha Gupta

arrangements are made more effective, trade is liberalised and

logistical efficiency increased (ibid.).
Further, MNEs have played a major role since the 1980s:
they have invested in India’s electrical machinery and automobile
industries, set up joint ventures due to government FDI regulation,
and procured some parts/components from local suppliers, owing
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to local content regulation. Rapid expansion in domestic demand

and competition led to the development of subcontracting in India.
More foreign assemblers and component manufacturers came into
the country and encouraged local assemblers to improve supply
chain management (Uchikawa, 2011).

Extent of Integration of India’s Machinery Sector

For finding out integration levels, India’s machinery sector is
compared to other countries; its development and IIT therein is
studied for 1990–2009.

India and Other Countries

Data for exports and imports for selected 34 countries (on the
basis of the work of Ando and Kimura [2009]) are collected from
‘COMTRADE database’ of ‘World Integrated Trade Solutions’
(WITS) software for total machinery goods and machinery parts
and components, and accordingly, their shares in world trade
are calculated.6 Data are graphically plotted from left to right,
beginning with the country which has highest export share of
machinery parts and components. The rule adopted is that the
more the country is located towards the left side of the graphs,
the more it is integrated into GPNs. Figure 13.3 and Figure 13.4
show the shares of machinery goods in total exports to and
imports from the world in 2005 and 2008/2009, respectively.7
In 2005, on the far left side, East Asian countries domi-
nated with very high shares and greater integration into GPNs.
Other countries, namely, Hungary, USA, Mexico, Costa Rica, UK,
Germany, Czech Republic, etc., have high shares. All these have
mainly exported machinery, especially parts and components. On
the right side, there are countries, particularly India, Colombia,
Argentina, Chile, Venezuela, Peru, etc., with very low proportion
of exports. Their imports are tremendously large, especially of fin-
ished goods.
 Downloaded by [University of Toronto] at 13:44 15 January 2017

Figure 13.3: Shares of Machinery Goods in Total Exports to and Total Imports from World in 2005

2005
%
90.00
80.00
70.00
60.00
50.00
40.00
30.00
20.00
10.00
0.00

UK

USA
Peru

India
Chile

Brazil

China

Korea
Latvia

Japan
Czech
Russia

France

Poland

Mexico
Estonia
Canada
Ecuador

Hungary
Slovakia

Thailand

Malaysia
Lithuania

Germany
Colombia
Argentina
Honduras

Indonesia

Singapore
Venezuela

Philippines
Costa Rica
Guatemala

Hong Kong
Exports: Parts and components in machinery goods Exports: Finished machinery goods
Imports: Parts and components in machinery goods Imports: Finished machinery goods

Source: Revised data (original source: Ando, Mitsuyo and Fukunari Kimura. 2009. ‘Fragmentation in East Asia: Further Evidence’, Economic Research
Institute for ASEAN and East Asia Discussion Paper ERIA-DP-2009-20, Jakarta.); Author’s calculation, WITS.
Integration of the Indian Machinery Sector into GPNs •3 0 9
 Downloaded by [University of Toronto] at 13:44 15 January 2017

Figure 13.4: Shares of Machinery Goods in Total Exports to and Total Imports from World in 2008/2009

% 2008/2009
80.00
70.00
310•Neha Gupta

60.00
50.00
40.00
30.00
20.00
10.00
0.00

UK

USA
Peru

India
Chile

Brazil

China

Korea
Latvia

Japan
Czech
Russia

France

Mexico
Estonia

Poland*
Canada
Ecuador

Thailand

Malaysia
Lithuania

Germany

Hungary*
Slovakia*
Colombia

Argentina

Indonesia
Honduras

Singapore
Venezuela

Philippines
Costa Rica
Guatemala

Hong Kong
Exports: Parts and components in machinery goods Exports: Finished machinery goods
Imports: Parts and components in machinery goods Imports: Finished machinery goods

Source: Author’s calculation, WITS Software.

Note: Countries with * have data for 2008.
 Integration of the Indian Machinery Sector into GPNs •3 1 1

Among 34 countries, India at the 24th position indicates

its low participation in GPNs. India’s exports’ share of machinery
parts and components is only marginally higher (0.46 per cent)
than that of finished machinery goods. But, the share of imports
of finished machinery goods is comparatively higher (by 4.39 per
cent) than that of intermediate goods.
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In 2009, shares of exports and imports of finished

machinery goods exceeded that of intermediate goods by 4 per
cent and 2.70 per cent, respectively. Thus, the trend is shifting
more towards exports of the former, but there is no drastic
change in the trade patterns of Indian machinery goods. Also,
India still holds the 24th position. India’s share of exports of total
machinery goods has increased by 4.88 per cent, with miniature
increase in its imports’ share (only 1.81 per cent). Thus, the
Indian machinery sector is not much integrated, in spite of some
improvements on all fronts.
Although export shares of most of the countries, which
were on the extreme left in 2005, have fallen, many of them are
still maintaining more or less similar positions, owing to the fact
that their supply chain in the machinery industry is already so
much developed that some fall in shares does not really affect it.
Another interesting finding is that mostly these highly
integrated countries have actually exported and imported very low
amounts of machinery goods (see Figures 13.5 and 13.6), such
as, the Philippines, Malaysia, etc. The reasons could be that these
countries are more dependent on their internal markets; or their
cost of production of machinery goods, especially intermediates, is
very low owing to extensive use of economies of scale, which has
raised their shares (for example, higher intra-regional machinery
trade in East Asia). Their other industries may not have as
dominating a role as the machinery sector.
Additionally, countries with very low shares are also hardly
trading. But, this is due to predominance of other industries, along
with high cost of production in machinery goods. The only excep-
tions being India and Brazil, which in spite of low shares, have
imported and exported some machinery goods.
In 2009, many countries have shown good performance,
like China, Poland, Hong Kong, Singapore, Korea, Czech Republic,
Thailand, Mexico, etc. For India, although trade shares have shown
some improvements, but the actual values of exports and imports
 Downloaded by [University of Toronto] at 13:44 15 January 2017

Figure 13.5: Actual Trade of Machinery Goods in 2005

800,000,000.000
700,000,000.000
312•Neha Gupta

600,000,000.000
500,000,000.000
400,000,000.000
300,000,000.000
200,000,000.000

Values in USD thousand

100,000,000.000
0.000

UK

USA
Peru

India
Chile

Brazil

China

Korea
Latvia

Japan
Czech
Russia

Poland
France

Mexico
Estonia
Canada
Ecuador

Hungary
Slovakia

Thailand

Malaysia
Lithuania

Germany
Colombia
Argentina
Honduras

Indonesia

Singapore
Venezuela

Philippines
Costa Rica
Guatemala

Hong Kong
Exports: Parts and components in machinery goods Exports: Finished machinery goods
Imports: Parts and components in machinery goods Imports: Finished machinery goods

Source: Author’s calculation, WITS Software.

 Downloaded by [University of Toronto] at 13:44 15 January 2017

Figure 13.6: Actual Trade of Machinery Goods in 2008/2009

700,000,000.000

600,000,000.000

500,000,000.000

400,000,000.000

300,000,000.000

200,000,000.000

Values in USD thousand

100,000,000.000

0.000

UK

USA
Peru

India
Chile

Brazil

China

Korea
Latvia

Japan
Czech
Russia

France

Mexico
Estonia

Poland*
Canada
Ecuador

Thailand

Malaysia
Lithuania

Germany

Hungary*
Slovakia*
Colombia

Argentina

Indonesia
Honduras

Singapore
Venezuela

Philippines
Costa Rica
Guatemala

Hong Kong
Exports: Parts and components in machinery goods Exports: Finished machinery goods
Imports: Parts and components in machinery goods Imports: Finished machinery goods

Source: Author’s calculation, WITS Software.

Note: Countries with * have data for 2008.
Integration of the Indian Machinery Sector into GPNs •3 1 3
 314•Neha Gupta

have been almost doubled. However, on comparison with many

other countries (especially those located towards the left side of
the graphs), India’s trade values in absolute terms still continue to
be very low.

India’s Position (1990–2009)

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Data from Figures 13.7 and 13.8 clearly show that India’s imports
of total machinery goods, intermediate and finished goods have
been much higher than that of their exports in each year during
1990–2009. However, overall increase in actual trade remained
much more than that of shares, with greater changes in exports
(tremendous increase of 1919.34 per cent from 1990 to 2009, with
gradual rise in shares by 8.32 per cent). Imports have risen by
1264.39 per cent over the same period, with only 4.34 per cent
increase in their shares.
There has been an outstanding rise of about 1211.42 per
cent in 1990–2009 in exports of parts and components (with shares
increased only by 1.52 per cent). Exports of finished machinery
goods have risen continuously by about 2897.68 per cent (shares

Figure 13.7: India’s Exports and Imports of Machinery Parts and Components
and Finished Goods, 1990–2009

80,000,000.000
70,000,000.000
Values in USD thousand

60,000,000.000
50,000,000.000
40,000,000.000
30,000,000.000
20,000,000.000
10,000,000.000

0.000
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

Years
Exports: Parts and components in machinery goods
Imports: Parts and components in machinery goods
Exports: Finished machinery goods
Imports: Finished machinery goods

Source: Author’s calculation, WITS Software.

 Integration of the Indian Machinery Sector into GPNs •3 1 5

increased only by 6.79 per cent). Year-wise, the former exceeded

the latter, except in 2009, when trends reversed. Whereas imports
of parts and components have risen continuously by 869.84 per
cent (shares saw a decline of 1.66 per cent), that of finished goods
have risen by 1921.96 per cent (shares have increased by 6 per
cent). From 2002 onwards, the imports of finished goods rapidly
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exceeded intermediates.

Figure 13.8: India’s Share of Machinery Goods, 1990–2009

%
18.00
16.00
14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

Years

Exports: Parts and components in machinery goods

Exports: Finished machinery goods
Imports: Parts and components in machinery goods
Imports: Finished machinery goods

Source: Author’s calculation, WITS Software.

It can be seen that India needs more of finished machinery

goods from other countries to speed up the growth of its industrial
sector and to become more capital-intensive. While imports of
intermediate capital goods are being made for increasing India’s
role in their assembling and in exporting more finished goods, these
exports are relatively low, indicating use of imported components
for domestic markets. In spite of moving up its line of suppliers of
intermediate goods, the Indian machinery sector is yet to become
 316•Neha Gupta

a full-fledged part of global supply chains. Some evidence is found

in the auto industry, where the supply chain is rapidly growing at
the car makers and their first-tier suppliers’ levels, though in a slow
manner for second-tier suppliers (Sutton, 2000).

India’s Intra-industry Trade (IIT)

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India’s IIT in machinery goods is quantified by using the standard

measure of Grubel-Lloyd (GL) Index (Tables 13.2 and 13.3).8

Table 13.2: Values of GLIi for HS 84-92

HS Code GLIi (1990) GLIi (2000) GLIi (2005) GLIi (2009)

84 45 45 48 46
85 46 60 39 57
86 72 32 32 16
87 96 63 47 65
88 5 60 6 35
89 24 16 52 89
90 23 42 42 43
91 16 89 91 46
92 15 58 97 83
Source: Author’s calculation, WITS Software.

In 1990, IIT has been much higher for products like HS

84–87, while it is low for other product labels, especially for HS 88
with only 5 per cent of IIT. Although the value of GLI fell in 2000 for
HS 86–87 owing to more protection, it has risen for all other products
significantly, especially for precision machinery, for which India is
emerging as the fastest growing market. Products like HS 89 and HS
92 have shown tremendous increase from 2000 onwards, owing to
exposure to increasing competition from world markets. Apart from
products like HS 86 (16 per cent), HS 88 (35 per cent), etc., all other
product categories have IIT around 50 per cent in 2009.
Overall, India’s IIT in machinery has been quite low which
is about half of the total trade, with growing trade deficit. But, GLI
increased by 9 per cent from 1990 to 2009, which is a good develop-
ment sign. Adjusted GLI has fallen from 98 per cent in 1990 to 87 per
cent in 2009, due to increase in exports in recent years.
 Integration of the Indian Machinery Sector into GPNs •3 1 7

Table 13.3: Values of GLIIndia and GLIajIND for HS 84-92

Years
1990 2000 2005 2009

GLIIndia 45 50 43 54
Trade Imbal-
ance (in USD 3304357.712 5367033.260 20144682.098 35773317.701
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Index thousand)

GLIajIND 98 87 81 87

Source: Author’s calculation, WITS Software.

Policy Framework
This situation can be explained by policies followed by India since
the 1990s. Before undertaking economic reforms, there were
strict bureaucratic controls and large import restrictions which
shackled India’s foreign trade, especially in capital goods. After
mid-1991, owing to the liberalisation process, the economy was
opened up for trade. Early abolition of import licensing for capital
goods and intermediates made them freely importable in 1993.
The quantitative restrictions on their imports were also removed
owing to lesser domestic producers (Ahluwalia, 2002). Joining
the World Trade Organisation (WTO) in 1995 also prompted India
to lower protection levels on domestic industry. The switch to a
flexible exchange rate regime; replacement of Foreign Exchange
Regulation Act (FERA), 1973, with Foreign Exchange Management
Act (FEMA), 1999; announcement of the Special Economic Zones
(SEZs) Policy, 2000, etc., were the few main steps to facilitate
external trade, liberalise and attract larger foreign investments in
Indian industries (especially in capital goods), reduce multiplicity
of controls and clearances and develop world-class infrastructure.
Reduction of tariff rates (Table 13.4) made imports double to
that of exports in almost each year during 1990–2009. It can be seen
that in initial years, just before liberalisation, tariff rates were very
high for all product categories in order to protect domestic industries.
In 1992, when the economy was opening up, tariff rates fell down,
shares of imports of finished machinery goods rose, while that of
intermediate goods did not rise owing to protection of local suppliers.
From 2005 onwards, tariff rates were greatly reduced which led to a
much higher increase in the imports, particularly of finished goods.
 318•Neha Gupta

Table 13.4: Simple Average Tariff Rates (India)

Tariff Product Codes (HS 2-digit level)

Years ’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92
1990 77.88 81.08 33.33 77.70 39.00 37.81 63.36 100.00 100.00
1992 47.88 57.16 38.33 61.58 44.00 40.00 54.83 65.00 30.00
Downloaded by [University of Toronto] at 13:44 15 January 2017

1997 21.81 30.99 34.38 39.47 16.60 16.76 26.84 33.82 30.00
1999 26.09 31.02 34.38 39.47 25.20 37.94 29.56 34.45 35.00
2001 25.66 27.29 31.25 48.36 20.20 30.29 25.81 31.73 35.00
2004 25.05 24.81 28.13 44.41 18.94 27.50 24.57 28.40 30.00
2005 14.34 12.18 15.00 31.58 10.50 15.00 13.07 15.00 15.00
2007 11.98 10.47 12.50 29.83 8.70 12.50 11.49 12.50 12.50
2008 7.05 6.90 10.00 27.61 6.27 8.89 7.75 9.17 10.00
2009 7.71 7.45 10.00 27.87 7.20 8.33 8.04 10.00 10.00
Source: Author’s calculation, WITS Software (TRAINS).

In order to increase exports of capital goods and regulate

their imports, the government has undertaken several policy
initiatives, like:
(a) Introduction of ‘Export Promotion Capital Goods (EPCG)
Scheme’ in the Import Export Policy, 1990–93 for import of
capital goods at a concessional rate of 25 per cent customs
duty. Since 2008, this scheme allows import of capital
goods at 3 per cent customs duty.9 Second-hand capital
goods, without any age restriction, are also allowed to be
imported.
(b) In the new Foreign Trade Policy (FTP), 2009–14, the
‘Zero Duty EPCG Scheme’ has been introduced for the
exporters of engineering and electronic products, subject
to exclusions as specified.10
(c) Electronic products, automobiles and other engineering
products have been included for incentives under Focus
Product, and Market Linked Focus Product Schemes.11
In spite of significant efforts, all such policies did not provide
much help towards integration of the Indian machinery industry, as
is reflected in its comparatively low shares and actual trade values,
due to reasons including more protection of segments of transport
and general machinery, dominance of services sector, etc.
 Integration of the Indian Machinery Sector into GPNs •3 1 9

Successful Formation of GPNs in East Asia

Since the 1990s, East Asian developing countries/LDCs also
started exporting capital-intensive final manufactured products
(like developed countries), which was not the case in the
1980s. Intra-industry trade started rising fast, with a focus on
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international production process-wise division of labour and trade

patterns. Complex and sophisticated GPNs, involving both inter-
firm and intra-firm transactions, were established owing to many
inherent factors. East Asia involves a huge number of countries,
with each having different sets of income and wage levels/factor
prices. Significant differences in location advantages,12 lower
transportation costs and trade barriers made trade [Link]
overcome distance issues between the countries, the SL costs have
been gradually reduced (Kimura, 2006; Haddad, 2007).
Over time, the shift in East Asian trading patterns (exports
to the Western world largely moved from light industrial/con-
sumer goods to highly capital-intensive goods) explains much of
the formation of GPNs. In the 1960s, countries like Japan (as the
major exporter of region) followed this approach and adopted a
strategy of actively utilising incoming FDI. In later decades, several
countries emerged and provided subcontracting services, mainly to
European and US firms, including the Japanese. For instance, in the
1970s, some countries, namely, Hong Kong, Korea, Singapore, and
Taiwan used intellectual properties of such firms for undertaking
assembling or production of final consumer goods. Eventually, the
capital intensity of their goods increased, with rising production
and innovation standards, especially when high-wage countries
moved their labour-intensive manufacturing stages to East Asian
economies. This way, late-comer economies also got a chance to
participate in the production of low-end consumer goods. In the
1980s and 1990s, countries like Indonesia, Malaysia, the Philip-
pines, and Thailand as well as China, Vietnam and Cambodia,
respectively, emerged by providing subcontracting services. They
soon specialised in the production of components/intermediate
inputs, especially labour-intensive ones provided by China, which
pushed forerunners up-market (Haddad, 2007).
This was accompanied by wide changes in trade and invest-
ment policies: From the 1960s to 1970s, many economies have
applied a ‘dual-track approach’ to develop simultaneously both import-
 320•Neha Gupta

substituting and export-oriented industries. But, until the mid-1980s,

there have been strict rules towards FDI. It was only in the later half of
the 1980s and early 1990s when FDI was invited and used aggressively,
due to adoption of the ‘accept everybody’ policy for incoming FDI,
mainly by ASEAN and China (though some sectors remain restricted).
Governments and policy makers improved FDI hosting services so as
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to meet even small requests of MNEs. An aggressive policy of inviting

foreign small and medium enterprises (SMEs) also worked effectively
in the formation of industrial clusters. Large resources have been spent
on the development of economic infrastructure. For investment facili-
tation, public and private sectors also ran industrial estates and parks
with all basic facilities. Enhancement of local firms also remained a
priority. For reducing the negative effects of trade protection kept for
import-substituting industries (automobiles, domestic electric appli-
ances, etc.), the South East Asian countries have introduced the
duty-drawback system (see Haddad, 2007; Ando and Kimura, 2005;
Kimura, 2006). Further, the signing of the ASEAN Free Trade Agree-
ment (AFTA) in 1993 was one of the important steps taken by ASEAN
member countries for attracting greater FDI and reducing tariffs. The
integration process of developing economies like China, Malaysia and
Thailand provides the best example.

China, Malaysia and Thailand

In 2009, Malaysia was more integrated into GPNs, followed by China
and Thailand. Their trade deficit has also turned into surplus from the
early 1990s to 2009, with considerable rise in IIT (Table 13.5).

Table 13.5: GL Index of IIT

Country Years GL Index Trade Imbalance

1992 61 17646364.568
China
2009 79 160542975.509
1990 72 4649554.458
Malaysia
2009 86 10698428.535
1990 54 9033890.530
Thailand
2009 84 11462418.159
Source: Author’s calculation, WITS Software.

However, China tops the list with tremendous growth

in actual trade, followed by Malaysia and Thailand (although,
Figures 13.5 and 13.6 show their less trade on the global platform,
 Integration of the Indian Machinery Sector into GPNs •3 2 1

but an individual look at them gives a different picture as reflected

in Figures 13.9–13.14).
Figures 13.9 and 13.10: China’s Machinery Trade, 1992–2009

800,000,000.000
Values in USD thousand

700,000,000.000
Downloaded by [University of Toronto] at 13:44 15 January 2017

600,000,000.000
500,000,000.000
400,000,000.000
300,000,000.000
200,000,000.000
100,000,000.000

0.000
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Years
Exports: Parts and components in machinery goods
Imports: Parts and components in machinery goods
Exports: Finished machinery goods
Imports: Finished machinery goods

%
40.00

35.00

30.00

25.00

20.00

15.00

10.00

5.00

0.00
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

Years
Exports: Parts and components in machinery goods
Exports: Finished machinery goods
Imports: Parts and components in machinery goods
Imports: Finished machinery goods
 Downloaded by [University of Toronto] at 13:44 15 January 2017

Figures 13.11 and 13.12: Malaysia’s Machinery Trade, 1990–2009

100,000,000.000
90,000,000.000
80,000,000.000
322•Neha Gupta

70,000,000.000
60,000,000.000
50,000,000.000
40,000,000.000
30,000,000.000

Values in USD thousand

20,000,000.000
10,000,000.000
0.000

1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

Years

Exports: Parts and components in machinery goods

Imports: Parts and components in machinery goods
Exports: Finished machinery goods
Imports: Finished machinery goods

(continued)
 Integration of the Indian Machinery Sector into GPNs •3 2 3

(continued) Figures 13.11 and 13.12

%
60.00

50.00
Downloaded by [University of Toronto] at 13:44 15 January 2017

40.00

30.00

20.00

10.00

0.00
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Year
Exports: Parts and components in machinery goods
Exports: Finished machinery goods
Imports: Parts and components in machinery goods
Imports: Finished machinery goods

Figures 13.13 and 13.14: Thailand’s Machinery Trade, 1990–2009

90,000,000.000
80,000,000.000
Values in USD thousand

70,000,000.000
60,000,000.000
50,000,000.000
40,000,000.000
30,000,000.000
20,000,000.000
10,000,000.000
0.000
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

Years

Exports: Parts and components in machinery goods

Imports: Parts and components in machinery goods
Exports: Finished machinery goods
Imports: Finished machinery goods
 324•Neha Gupta

(continued) Figures 13.13 and 13.14

%
40.00
35.00
30.00
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25.00
20.00
15.00
10.00
5.00
0.00
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Years

Exports: Parts and components in machinery goods

Exports: Finished machinery goods
Imports: Parts and components in machinery goods
Imports: Finished machinery goods

Sources: Author’s calculation, WITS Software.

In China, initially the trade values (Figure 13.9) and

shares (Figure 13.10) of imports of total machinery goods (rise
of 1325.34 per cent and 5.94 per cent, respectively, during 1992–
2009) were higher, but after the mid-2000s, exports increased
rapidly (registered greater rise of 3905.85 per cent and 34.43 per
cent in terms of values and shares, respectively — almost double
that of India’s). All this is attributed to more openness of their
trade regime, with dominance of trade in goods; reduction in non-
tariff barriers; and most importantly, huge FDI inflows. Joining the
WTO in 2001 brought more transparency and facilitated lowering
of tariff rates. China also hosted a large number of export-oriented
foreign businesses. Further, schemes like duty exemptions, rebates
of value added tax system, etc., were introduced to facilitate
processing trade (Ianchovichina and Martin, 2001). There have
always been higher imports of intermediate goods than their
exports. Also, such imports for use in exports’ production were
 Integration of the Indian Machinery Sector into GPNs •3 2 5

almost liberalised (for example, capital goods inputs for use in joint
ventures with foreign enterprises), which also stimulated export-
processing industries that rely heavily on them (ibid.). Exports of
finished goods have risen tremendously (values and shares risen by
4418 per cent and 19.75 per cent, respectively, during 1992–2009)
to exceed their imports, whose share is continuously falling (by
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10.11 per cent). This also exceeds exports of parts and components
(shares of exports and imports of intermediate goods increased by
14.69 per cent and 16.04 per cent, respectively, against vital rise
in their trade values by 3622.69 per cent and 2273 per cent during
the same period). China’s dominant role in East Asia in assembling
parts and components imported heavily from other regions/Asia
and making finished products from them, for exporting to Western
consumers, supports this data (Haddad, 2007; Gaulier et al., 2007;
Tong, 2008).
Major changes occurred in trading patterns of Malaysia
and Thailand, especially after signing AFTA in 1993 and joining
WTO in 1995. In Malaysia, after 1997, exports of total machinery
goods became more than their imports (Figure 13.11). But, share-
wise (Figure 13.12), imports have always exceeded exports, owing
to very low tariff rates on imports. Malaysia’s manufacturing
sector was early on opened up to trade and foreign investment
(generally allowed 100 per cent), along with simplification of
the tariff structure. As an old player, it has witnessed tremendous
back-and-forth transactions in trade of intermediate goods
(considerably larger than trade in finished goods), especially
their rising imports. But, after 2008, their exports also picked up
rapidly to surpass imports. In addition, there are higher values
and shares of exports of finished goods than imports, indicating a
greater role in assembling of parts and components. Measures like
duty drawback schemes, import tariff concessions, tax exceptions,
export credits, insurance, guarantees, etc., helped in enhancing
exports. Free industrial zones and licensed manufacturing
warehouses are maintained with minimum customs formalities for
export processing (Athukorala, 2005). During 1990–2009, shares
of exports of total machinery goods, intermediate, and finished
goods increased by 12.54 per cent, 8.23 per cent and 4.31 per
cent, respectively, as against rise in their trade values by 613.70
per cent, 620.38 per cent and 602.18 per cent. Import shares have
increased for total and intermediate goods by 1.26 per cent and
 326•Neha Gupta

8.54 per cent, respectively (trade values have risen by 332.51 per
cent and 438.43 per cent), while that of finished goods have fallen
down by 7.28 per cent (absolute value increased by only 184.11
per cent).
In initial years till 1997, the government of Thailand
followed a strategy of importing more machinery goods so as
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to generate and sustain exports, thereafter which the trend

reversed (Figure 13.13). But, share of exports became higher
only after 2003 (Figure 13.14). It increased tremendously by
19.32 per cent during 1990–2009 (trade increased by 1102.86
per cent), while imports fell down by 3.05 per cent (as against
a total increase in trade value of 272.66 per cent). The Thai
government followed an aggressive export promotion policy,
mainly by granting duty and tax exemptions to export-oriented
projects. Tariffs were reduced gradually. Imports of intermediate
goods remained higher than their exports, and surpassed
imports of finished goods which has falling shares (by 3.80 per
cent). From 1998, exports of finished goods started rising and
exceeded their imports. In recent times, this is more than exports
of intermediate goods. From 1990 to 2009, a rise of 774.63 per
cent has been observed in exports of intermediate goods, with
their shares increasing only by 4.83 per cent. An increase in
shares of imports of intermediates is almost negligible (only 0.75
per cent), as compared to rise in their absolute values of 312.93
per cent. Rise in values and shares of exports of finished goods
has been reasonably impressive, that is, rise of 1669.85 per
cent and 14.49 per cent, respectively. Foreign investments and
MNEs played a significant role in export growth of machinery
industries, particularly, the electric, office and computing
machinery sectors (also relatively large shares in non-electric
machinery industry) (James and Ramstetter, 2008).
Thus, the machinery industry of these economies is at an
advanced development stage owing to outward-oriented industri-
alisation strategy and timely fall in tariff rates on imports (Table
13.6). In recent years, even though exports of parts and compo-
nents continued to be higher, their imports have increased tremen-
dously indicating more participation of these economies in assem-
bling. Accordingly, exports of finished goods have risen signifi-
cantly, while imports have declined. Almost all sectors have largely
been opened by removing protection on them, except automobiles.
 Integration of the Indian Machinery Sector into GPNs •3 2 7

Table 13.6: Simple Average Tariff Rates (China, Malaysia and Thailand)

Tariff Product Codes (HS 2-digit level)

Years ’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92
China
1992 27 39 8 69 6 14 26 65 55
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2000 14 17 5 35 3 8.7 13 21 23
2009 7.6 8.2 4 16 2 7.3 7.1 16 18
Malaysia
1991 5.5 16 5 23 7 20 6.2 2.9 16
2001 3.4 8.2 4 30 1 2.9 1.7 0.8 2
2007 3.3 6.2 4 18 1 1.7 0.6 0.8 0.9

Thailand
1991 32 41 5 53 5 33 33 45 41
2000 8.7 14 3 36 3 9.4 7.2 11 11
2006 4.5 9.4 3 32 3 5.6 4.9 8.4 11
Source: WITS Software.

Implications for India

East Asia’s developing countries have been much successful in the
formation of strong GPNs, while India is yet to make its mark in this
field. Their government has been actively involved in the growth
of industrial clusters or agglomerations, where local firms also
play a lively role along with MNEs. Some well-developed ones are:
Shanghai-Jiangsu corridor and Guangzhou and its vicinity in China;
Samut Prakan and the Eastern Seaboard in Thailand; and Penang
and Shah Alam in Malaysia (Kimura, 2006). In India, although
there are some evidences of progress in this direction, there is an
urgent need to upgrade industrial clusters formed in sectors like
auto-components, ICTs, electronics, and semiconductors, etc.
Like East Asia, infrastructure should be more developed
in India for improving connectivity and for better transportation
of goods. Time and costs involved in customs clearance services
should also be reduced. There is a need to gradually decrease tariff
rates on goods imported for export production and implement
proper duty exemption or drawback schemes. More foreign
 328•Neha Gupta

investments must be called in manufacturing sector, especially

export-oriented FDI, as: ‘Unlike the case in China and southeast
Asia, foreign direct investment in India did not play an important
role in export penetration and was instead oriented mainly toward
the domestic market’ (Ahluwalia, 2002: 75).
All these do not imply that the East Asian GPNs model
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should be directly imitated in the Indian scenario, as both of these

economies are very different in terms of trade and investment
climate. East Asians have followed export-led industrialisation,
while in India there is a large domestic demand whose fulfillment is
a matter of prime concern. Keeping in view the needs of the Indian
economy, its social and political aspects, etc., the present indus-
trial, trade and investment policies/schemes should be revised.
Advantages like existence of huge manpower, low wage levels,
growing trade relations with neighbouring and ASEAN countries,
etc., should be further refined. Innovation and promotion of more
R&D activities in the manufacturing sector are essential.
Value addition step (including assembling of goods) holds
a lot of potential, which must be carried out in a decisive manner.
Along with these, the Indian suppliers’ market should be devel-
oped for increasing more exports in intermediate goods. Like
China, India should enhance its role in producing finished goods
to be supplied to the outside world.

Conclusion and Recommendations

Our analysis shows very low integration of India’s machinery sector
in GPNs, with less IIT therein. But, there exist enormous opportu-
nities which need to be tapped and worked upon. Various hubs
in India for different segments of industry should be identified
and promoted in all zones of India: west, north, south, and east.
For example, Pune, Mumbai, Delhi and NCR, Bangalore, Kolkata,
Chennai, Jamshedpur, etc., have major clusters for automobiles
and engineering products. Some of these, including Gujarat and
Hyderabad, have key players for ICT products. Some regions of
Madhya Pradesh and Rajasthan are also emerging as major des-
tinations. For electric machinery and electronics, several parts
of Haryana, Uttar Pradesh, Gujarat, Maharashtra, Chennai, etc.,
hold huge capabilities. Ports like Vishakhapatnam, Goa, etc., are
 Integration of the Indian Machinery Sector into GPNs •3 2 9

hotspots for ships and related equipments. Moreover, India should

try to host FPBs pushed out of congested agglomerations in East
Asia and neighbouring countries, and initiate more projects like
‘Mekong-India Economic Corridor (MIEC)’.13
The extent of integration of each product category within
group HS 84–92 should be assessed separately to understand
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where supply chains could be formed and/or improved. In addi-

tion, there is a need to understand industry-wise responses in
India. That is, attempts should be made to understand the reasons
for low participation of Indian machinery firms in supply chains,
constraints being faced by them, their expectations from central
and state governments, policy changes that are desired, etc. These
are the initial steps that must be followed for making appropriate
policies for the machinery sector.

Notes
1. HS 84–92 (Machinery Sector as defined by Kimura and Ando [2005]
and Ando and Kimura [2009]) HS 84: nuclear reactors, boilers,
machinery, etc.; HS 85: electrical, electronic equipment; HS 86:
railway, tramway locomotives, rolling stock, equipment; HS 87:
vehicles other than railway, tramway; HS 88: aircraft, spacecraft, and
parts thereof; HS 89: ships, boats and other floating structures; HS
90: optical, photo, technical, medical, etc. apparatus; HS 91: clocks
and watches and parts thereof; and HS 92: musical instruments, parts
and accessories.
2. Definition of Machinery Parts and Components (HS Classification) —
840140, 840290, 840390, 840490, 840590, 8406, 8407, 8408,
8409, 8410, 8411, 8412, 8413, 8414, 841520, 841590, 8416,
8417, 841891, 841899, 841990, 842123, 842129, 842131, 842191,
842199, 842290, 842390, 842490, 8431, 843290, 843390, 843490,
843590, 843680, 843691, 843699, 843790, 843890, 843991,
843999, 844090, 844190, 844240, 844250, 844390, 8448, 845090,
845190, 845240, 845290, 845390, 845490, 845590, 8466, 846791,
846792, 846799, 846890, 8473, 847490, 847590, 847690, 847790,
847890, 847990, 8480, 8481, 8482, 8483, 8484, 8485, 8503, 850490,
8505, 850690, 8507, 850890, 850990, 851090, 8511, 8512, 851390,
851490, 851590, 851690, 851790, 8518, 8522, 8529, 853090, 8531,
8532, 8533, 8534, 8535, 8536, 8537, 8538, 8539, 8540, 8541, 8542,
 330•Neha Gupta

854390, 8544, 8545, 8546, 8547, 8548, 8607, 8706, 8707, 8708,
870990, 8714, 871690, 8803, 8805, 9001, 9002, 9003, 900590,
900691, 900699, 900791, 900792, 900890, 900990, 901090,
901190, 901290, 9013, 9014, 901590, 901790, 902490, 902590,
902690, 902790, 902890, 902990, 903090, 903190, 903290, 9033,
9110, 9111, 9112, 9113, 9114, 9209 (Ando and Kimura, 2009).
3. GCCs are defined as: consisting of a number of ‘nodes’ that comprise
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the pivotal points in the production process; extraction and supply

of raw materials, the stage(s) of industrial transformation, export of
goods, and marketing. Each node is itself a network connected to
other nodes of related activities, such that local, regional and world
economies are seen as ever more intricate web-like structures of these
chains.
4. GPNs are defined as, ‘the globally organized nexus of interconnected
functions and operations by firms and non-firm institutions through
which goods and services are produced and distributed. Such net-
works not only integrate firms (and parts of firms) into structures
which blur traditional organizational boundaries through the devel-
opment of diverse forms of equity and non-equity relationships, but
also integrate regional and national economies in ways that have
enormous implications for their developmental outcomes. At the
same time, the precise nature and articulation of firm-centered pro-
duction networks are deeply influenced by the concrete socio-political
contexts within which they are embedded. (Henderson et al., 2002;
Coe et al., 2004). Coe et al. (2004) focus on the dynamic ‘strate-
gic coupling’ of GPNs and regional assets, an interface mediated by
a range of institutional activities across different geographical and
organisational scales. It stipulates that regional development will
ultimately depend on the ability of this coupling to facilitate the proc-
esses of value creation, enhancement and capture.
5. IPN is defined as ‘the organisation, across national borders, of the
relationships (intra and increasingly inter-firm) through which firms
conduct research, development, product definition and design, pro-
curement, manufacturing, distribution and support services’ (Borrus,
1996) (as cited in Gaulier et al., 2007: 29).
6. ‘WITS’ is software developed by the World Bank in close collaboration
and consultation with various international organisations, including
UN Conference on Trade & Development (UNCTAD), International
Trade Centre (ITC), UN Statistical Division (UNSD), and World Trade
Organisation (WTO). It gives access to major international trade,
tariff and non-tariff compilations, such as, UN COMTRADE database
maintained by UNSD; the TRAINS by UNCTAD; etc. It is a data con-
sultation and extraction software with simulation capabilities.
 Integration of the Indian Machinery Sector into GPNs •3 3 1

7. Figure 13.3 has been prepared on the basis of the graph given by
Ando and Kimura (2009), in their research, for demonstrating the
significance of machinery trade in East Asia in 2005, which shows
the shares of machinery goods (HS 84–92) and machinery parts and
components in total exports to and imports from the world in 2005
for major economies in East Asia and other regions. As data for the
latest figure is now collected from WITS software, the shares have
Downloaded by [University of Toronto] at 13:44 15 January 2017

undergone some minor revisions.

8. GL Index is one of the standard tools which measures IIT as a per-
centage of a country’s total trade (exports plus imports) which is as-
sumed to be balanced, that is exports equal imports. The value of
index lies between 0 (no IIT – trade is one-way) and 100 (complete
IIT – trade is balanced). For an individual product group or industry
i, GL Index is calculated by using the formula: GLIi = [(Xi + Mi) 
|Xi  Mi|].100/(Xi + Mi), where Xi= exports of industry i; and Mi=
imports of industry i (India’s machinery industry). The formula GLIj
= {[(¦(Xi + Mi)  ¦|Xi  Mi|)].100/¦(Xi + Mi)} is used to obtain
the average level of intra-industry trade for a country j, where i is the
ith of n industries (for India’s average IIT: GLIIndia). These formulae
do not allow for imbalance in a country’s total trade, and accordingly
adjusted GL index (GLIaj) is used. For adjusted GLI, the denominator
of GLIj is reduced by the amount of country j’s overall trade imbal-
ance. GLIaj = [(¦(Xi + Mi)  ¦|Xi  Mi|)]. 100/(¦(Xi + Mi) |¦ Xi
 ¦Mi|). For India, it is calculated as GLIajIND.
9. This new scheme allows the import of capital goods for pre-
production, production and post-production (including CKD/SKD
thereof as well as computer software systems) at 3 per cent customs
duty, subject to an export obligation equivalent to eight times of duty
saved on capital goods imported under the EPCG scheme (50 per cent
of export obligation in case of import of spares), to be fulfilled in eight
years reckoned from authorisation issue date. Here, spares (including
refurbished/reconditioned spares), moulds, dies, jigs, fixtures, tools,
refractory for initial lining and catalyst for initial charge, for existing
plant and machinery (imported earlier, under EPCG or otherwise),
are allowed to be imported under the EPCG scheme subject to an
export obligation equivalent to 50 per cent of the normal export
obligation prescribed for import of capital goods, to be fulfilled in
eight years (six years for zero duty EPCG scheme), reckoned from
authorisation issue date.
10. The zero duty EPCG scheme allows the import of capital goods for
pre-production, production and post-production (including CKD/SKD
thereof as well as computer software systems) at zero customs duty,
subject to an export obligation equivalent to six times of duty saved
 332•Neha Gupta

on capital goods imported under the EPCG scheme, to be fulfilled

in six years reckoned from authorisation issue date. It was to be in
operation till 31 March 2011. Also, it includes exporters of products
like basic chemicals and pharmaceuticals, apparels and textiles,
plastics, handicrafts, chemicals and allied products and leather and
leather products. However, this scheme shall not be available for
import of capital goods relating to export of products covered under
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following chapters/headings of ITC(HS) classification: Chapters 1 to

24, 25 to 27, 31, 40, 43, 44, 45 , 47 to 49, 68 to 70, 71, 81 (metals
in primary and intermediate forms only), 89 (ships, boats and other
floating structures), 93, 97, 98, 7201 to 7212, 7218 to 7220, 7224
to 7226, 7401 to 7406, 7501 to 7504, 7601 to 7603, 7801, 7802,
7901 to 7903, 8001, 8002 and 8401 (nuclear reactors; fuel elements
(cartridges), non-irradiated, for nuclear reactors; machinery and
apparatus for isotopic separation; parts thereof).
11. In order to give significant boost to market penetration of specific
products in specified markets, a variant under the Focus Product
Scheme (FPS) called ‘Market Linked Focus Product Scheme’ (MLFPS)
has been introduced from April 2008. Products of high export intensi-
ty (which are not covered under the present FPS List) but which have
a low penetration in countries (which are also not covered under the
present Focus Market Scheme list) are incentivised and entitled to
duty credit scrip equivalent to 2 per cent of the FOB value of exports,
provided that the products/sectors are destined to specified linked
markets for that particular product/sector. Presently, the products
covered under the scheme include motor vehicles, auto components,
apparels, knitted and crocheted fabrics, pharma products, value-
added plastic and rubber goods, glass products, dyes and chemicals,
household articles of aluminium, machine tools, earth moving equip-
ments, transmission towers, electrical and power equipments, steel
tubes/pipes/galvanised sheets, compressors, iron and steel struc-
tures, three wheelers, etc. The countries covered under the scheme
include Algeria, Egypt, Kenya, Nigeria, South Africa, Tanzania, Brazil,
Mexico, Ukraine, Australia, New Zealand, Cambodia, Vietnam, Ja-
pan, and China.
12. For example, proximity of one economy to another in East Asia proved
to be beneficial for facilitating both production and trade activities;
MNEs invested more keeping in view lower wage levels; etc. In fact,
trends were observed as: ‘income growth in one country increases the
demand for intermediate inputs produced in nearby countries, which,
by allowing input producers to enjoy economies of scale, lowers in-
put production costs and enhances regional growth’ (Kimura, 2006;
Haddad, 2007).
 Integration of the Indian Machinery Sector into GPNs •3 3 3

13. For deepening economic integration in East Asia as well as to over-

come India’s problems in developing supply chains, one of the main
initiatives is the launch of ‘Mekong-India Economic Corridor (MIEC)’,
which integrates four Greater Mekong Countries, namely, Myan-
mar, Thailand, Cambodia, and Vietnam with India through its east
coast. That is, it proposes to connect Ho Chi Minh City (Vietnam)
with Dawei (Myanmar) via Bangkok (Thailand) and Phnom Penh
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(Cambodia) and further linking to Chennai in India. The vision is

to make a provision of world class infrastructure and facilitate trade
between the Mekong region and India. This is to facilitate invest-
ments, mainly FDI, and industrial development (ERIA, 2009).

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Chicago Press, pp. 177–216.
———. 2009. ‘Fragmentation in East Asia: Further Evidence’, Economic
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Athukorala, P. 2005. ‘Trade Policy in Malaysia: Liberalization Process,
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———. 2009. ‘The Spatial Structure of Production/Distribution Networks
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 14
Value Chain in the Light
Engineering Sector of Bangladesh:
Challenges towards the Development of
Regional Linkages
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Khondaker Golam Moazzem and

Mehruna Islam Chowdhury

B
uilding competitiveness and taking part in the international
value chain often become challenging for industries of the
least developed countries (LDCs) owing to various internal
and external constraints. The light engineering sector (LES) of
Bangladesh which comprises the considerable share of small- and
medium-scale enterprises (SMEs), despite their substantial contri-
bution in the GDP and employment, is struggling to build its com-
petitiveness both at local and global levels.1 Notwithstanding their
limited scale of operation, less use of state-of-the-art technologies
and less manufacture of diversified products, there are a few exam-
ples of success where domestic industries are increasingly taking
on the role of import-substitution.
The light engineering industries (LEIs) of Bangladesh
comprise diverse categories of industries which include machineries
and spare parts, moulds and dies, vehicle and transport equipments,
etc.2 The sector is recognised as one of the ‘priority sectors’ in the
successive industrial policies of 1999, 2001, 2005, and 2010. Given
the difference in terms of use of capital and labour, technology use
and size of the market, etc., the industry-wise contribution in terms
of value addition and employment generation is not the same.3
While there are successful examples of regional value chains
in the case of small and medium industries including LEIs of neigh-
bouring regions, Bangladesh’s LEIs have yet to develop such value
chains with regional industries. In the East and South East Asian
regions, a number of value chains operate efficiently as in the case
of the automotive industry, scientific and precision instruments and
software industries. Various horizontal and vertical linkages have
been developed within the region taking the advantage of regional
 Value Chain in the Light Engineering Sector of Bangladesh •3 3 7

integration agreements/arrangements such as the Association of

South East Asian Nations (ASEAN), Asia Pacific Economic Coop-
eration (APEC) and the East Asia Summit (EAS). Regional value
chains on SME products have been developed in South East and
East Asia with the presence of strong regional integration which
facilitates the development of different segments in different parts
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of the region. The underlying assumption behind the development

of such value chains is reducing the cost of production based on
the competitiveness of industries of different locations. This study
is motivated by such developments in the neighbouring regions.
Establishing regional linkages has been regarded as a dominant
factor in ascertaining the economic success of the East and South
East Asian nations. More importantly, while these countries have
taken the full advantage of new production methods (Athukorala,
2006), South Asia is yet to use these to its advantage.
This Chapter aims to explore the challenges faced by the
LEIs of Bangladesh in the case of forming regional value chains. In
this context, it focusses on the development of a value chain of two
light engineering industries, namely razors and razor blades and
bicycles, and tries to identify their challenges towards developing
regional linkages.
The chapter comprises eight sections. A brief literature
review is presented in the second section. A generic structure of
the value chain of the LES of Bangladesh is provided in the third
section. Methodology of the study is discussed in the fourth section.
The fifth section provides an analysis of intra-industry trade of
the LES of Bangladesh. An analysis of value chains of selected LE
products is given in the sixth section. Various challenges regarding
trade and other barriers which impede the competitiveness of the
sector are discussed in the seventh section. Finally, the Chapter
puts forth recommendations on the development of regional value
chains in the LES of Bangladesh in the eighth section.

Literature Review
A well-integrated value chain ensures assembling of products
manufactured under the product fragmentation system in
dispersed locations (Athukorala, 2006; Athukorala and Yamashita,
2006).4 A crucial dimension in this case are the linkages between
industries in terms of their spatial nature and scale. A value
 338•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

chain can be at local, domestic, international, regional, or at a

global scale depending upon the selection of productive actors
(Sturgeon, 2001). This selection of actors depend upon the choice
of sources of inputs to lower cost or more efficient producers,
entry into comparatively large growing markets and searching of
complementary and strategic assets (OECD, 2007).
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Small firms, by exploiting their advantages of being flexible

in using production methods may resort to cross-border integration
(Sakai, 2002). The SMEs that have integrated in the regional and
local value chains view technological capabilities as critical and
which need to be continuously developed to remain competitive
in the global market; this has been possible for these industries
due to the pressure from the competing countries (OECD, 2007).
Modification of the value chain of these firms has further led to the
partition of research and development functions. In the developing
countries, SMEs can overcome the obstacles they face regarding
technological advancement, research and development capacity
and maintaining product standard up to the global market through
reconfiguring their value chains and developing regional linkages
(ibid.).
Based on the literature it can be ascertained that although
the regional locations have been considered suitable for develop-
ing value chains because of various kinds of advantages, the devel-
opment of the value chain depends on the suitability of each of the
specific locations in terms of various aspects related to production,
technology, manufacturers, marketing, and profitability point of
view. Examining the value chain of LEIs of Bangladesh with regard
to the possibility of development of regional linkages needs to take
those issues into account.

The Value Chain of LES of Bangladesh: A Generic

Structure
The overall investment of the LES is roughly about US$ 2.5 billion
which mainly targets different kinds of finished, intermediate and
some raw materials. The sector has a significant contribution in
the case of the manufacturing of irrigation pumps and equipments,
rice husking machines, tea plantation and processing, trawlers
used for catching fishes in the sea and different kinds of electrical
 Value Chain in the Light Engineering Sector of Bangladesh •3 3 9

appliances. According to the Bangladesh Engineering Industries

Owners Association (BEIOA), local industries could supply only
30 per cent of the total domestic market for light engineering
products which is worth about US$ 7 billion.5 A brief review of the
various segments of the value chain of the LE sector is provided in
the following paragraphs along with a generic value chain of LE
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products in Figure 14.1.

Figure 14.1: Generic Value Chain of LES

Casting

Processing
Marketing of
Procurement Products in
Packaging and
and Testing of Heat Treatment the Domestic/
Storage
Raw Materials International
Markets
Testing of
the Finished
Product

Final Product

Source: Based on the discussion with Md. Masum Talukder, Secretary General, BEIOA at Light
Engineering Association on 16 October 2010.

Procurement of Raw Materials

The LEIs mainly use different kinds of metals (steel, cast iron and
various other metallic products) and rubber as raw materials for
their production. These raw materials are usually procured from
breaking ships which are available locally (Maxwell Stamp Ltd.,
2009). Thus local industries enjoy the benefit of short lead time and
the low prices of raw materials which are considered to be advan-
tageous in terms of competitiveness. While local sources of raw
materials are by and large sufficient for domestic market-oriented
industries, these sources are not sufficient for large-scale produc-
tion of export-oriented industries. Therefore, export-oriented firms
with comparatively large-scale production usually import raw
materials and intermediate products mainly from Central Asia, the
 340•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

US and the European countries. South Asian countries are usually

less sourced for these raw materials.

Processing of Raw Materials

Most industries depend on indigenous technologies for processing
of raw materials, which are usually called ‘second-generation’
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technologies. Due to low investment, small size of the market,

poor physical infrastructure with involvement of risks, these small
industries find it difficult to upgrade their technologies or opt for
substitute indigenous techniques such as handmade tools, which
are cheap and easy to repair. Often, old or semi-modern machines
are used in the LEIs such as lathe, shaper and milling, etc. For
example, heat treatment is an important production stage for LE
products. As the machinery required for this stage is expensive,
the small LEIs use coal and molasses for heat treatment. Relatively
better technologies are used in the export-oriented industries
which are mostly imported machineries for large-scale operation.

Production and Marketing of Products

Marketing strategies of the LEIs depend on the final destination of
the manufactured products. Local market-oriented small industries
usually sell their products through local sales agents, while com-
paratively large firms sell their products through their appointed
dealers. The marketing strategy of the export-oriented industries
also varies among firms. Some firms sell their products directly to
the retailers of foreign countries, while others appoint their own
agents in the destination countries. Some of these firms sell their
products to local markets as well.
As mentioned earlier, the major share of light engineering
products is sold to the domestic market; export of LEI, though
at a limited scale, has been increasing over the years. During FY
2009–10, total export of light engineering products was US$ 289
million which was 38 per cent higher compared to the previous
year (Table 14.1). Major export destinations of these products
are outside South Asia, mainly in North America, Middle East
and Asia. Export to South Asian countries is in most cases very
low (Figure 14.2).
 Value Chain in the Light Engineering Sector of Bangladesh •3 4 1

Table 14.1: Bangladesh’s Export of Different LEPs

Product Export (mil. US$)

Name of Product
Code (HS) 2008–09 2009–10
40 Rubber and articles thereof 5.8 9.7
72 Iron and steel 32.9 44.6
84 Electrical, electronic equipment 22.8 26.1
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85 Railway, tramway locomotives, equipment 17.7 23.2

87 Aircraft, spacecraft and parts thereof 86.8 130.7
88 Ships, boats and other floating structures 0.0 1.0
90 Clocks, watches and parts thereof 14.5 14.9
92 Arms and ammunition, parts and accessories 0.0 0.0
94 Toys, games, sports requisites 8.9 19.3
95 Miscellaneous manufactured articles 11.8 11.6
96 Works of art, collectors, pieces and antiques 7.9 8.2
TOTAL 209.0 289.3
Source: Based on the data collected from the Website of Export Promotion Bureau (EPB),
Government of Bangladesh ([Link], accessed December 2010).

Figure 14.2: Export of Bangladesh’s LEPs to the World and South Asia, 2007

140,000
Export Value (in US$ '000)

120,000
100,000
80,000
60,000
40,000
20,000
0
62 67 69 71 72 73 74 75 76 77 78 79 81 87 89
Code of Light Engineering Products (SITC rev 3)

Bangladesh’s Export to World

Bangladesh’s Export to South Asian Region

Source: Authors’ calculation based on the World Integrated Trade Solution (WITS) database
([Link]/wits/, accessed October 2010).
 342•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

Methodology of the Study

With a view to identify the nature and extent of linkages of the
value chains of LEIs of Bangladesh with regional locations, this
study has analysed the intra-industry trade of light engineering
products. Both primary and secondary data are used for this
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purpose. To evaluate the extent of intra-industry trade of the light

engineering products, an analysis of the Grubel-Lloyd (G-L) index
has been carried out.6 It has been estimated by using the following
formula:

( )
|Exporti,r  importi,r|
IITi,r  1 ___________________
Exporti,r  importi,r
Where, ‘i’ is the product group and ‘r’ is the trading partner.
The index value may vary from a minimum of ‘0’ to a
maximum of ‘1’, indicating no intra-industry trade and pure intra-
industry trade respectively. Since a high G-L index may lead to over-
estimation in the extent of trade, a weighted G-L index has been used
in this study.7 The weight for the product ‘i’ has been calculated as
follows:

( )
Exporti,x,y  importi,x,y
Weighti,x,y  ___________________
Exportx,y  importx,y
where,
Export i, x, y = Country x’s export of commodity i to country y
Import i, x, y = Country x’s import of commodity i from country y
Export x, y = Country x’s total export to country y
Import x, y = Country x’s total import from country y
An attempt has been made to find out the comparative
advantage of Bangladesh in light engineering products with other
South Asian countries. Thus, an analysis of revealed comparative
advantage (RCA) has been carried out. The formula for estimating
RCA is:
RCA= (xijr / xitr) / (xnjr/ xntr)
where,
Xijr = Export of commodity j from country i to country r
Xitr = Export of a set of commodities from country i to country r
 Value Chain in the Light Engineering Sector of Bangladesh •3 4 3

A value of RCA greater than 1 indicates that the country

has comparative advantage for that particular commodity with
respect to the world. For the purpose of the study, data was
extracted from the United Nations Commodity Trade Statistics
Database (UN Comtrade) using Standard Industrial Classification,
Revision 3 (SITC, Rev 3).
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Besides, exploratory analyses on two light engineering

industries have been carried out with a view to get an in-depth
understanding on the development of the value chains in these
sectors. These industries are those of razor and razor blades and
bicycle industries. For this purpose, primary data are collected
regarding technology, machineries, sourcing strategies at different
stages of production of these industries. To identify the challenges
faced by the entrepreneurs in these sectors, a number of interviews
and focus group discussions (FGDs) have been carried out. Based
on this information, the study put forward suggestions with regard
to the development of regional value chains in the LEIs.

Current State of Regional Value Chain of Light Engi-

neering Products: Analysis of Intra-Industry trade
For the purpose of observing the extent of intra-industry trade
between Bangladesh and its neighbouring countries, the Grubel-
Lloyd Index has been calculated in this study for three bilateral
pairs (i.e., Bangladesh–India, Bangladesh–Pakistan and Bangla-
desh–Sri Lanka). Analysis shows that Bangladesh has a very insig-
nificant level of trade with its neighbouring countries (Table 14.2).
The results are found to be similar even in further disaggregated
level-GLI at the three-digit level (see Appendix III, IV and V). In
contrast, the estimated value of the intra-industry trade for bilat-
eral pairs of selected ASEAN countries is found to be relatively high
(Table 14.3).
These results show that the LEIs of Bangladesh have negli-
gible linkages with those of other South Asian countries. Thus, the
existing trade pattern between light engineering industries of Bang-
ladesh and those of other countries reflects an almost absence of
backward and forward linkages of the value chains within the region.
 344•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

Table 14.2: Weighted GLI for LEPs (at two-digit level) with
South Asian Countries in 2007

Code Bangladesh–India Bangladesh–Pakistan Bangladesh–Sri Lanka

67 0.001 0.000 0.001
69 0.002 0.001 0.004
71 0.000 0.001 0.005
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72 0.003 0.007 0.017

73 0.001 0.000
74 0.001 0.000 0.009
75 0.000 0.000 0.000
76 0.002 0.000 0.000
77 0.007 0.001
78 0.000
79 0.000
81 0.000
87 0.000 0.000
89 0.001 0.006 0.046
Source: Authors’ calculation based on the World Integrated Trade Solution (WITS) database
([Link]/wits/, accessed October 2010).

Table 14.3: Weighted GL Index Values for LEPs (at two-digit level) in
Selected ASEAN Countries

Product Name Singapore–Thailand Singapore–Malaysia

Power generating machinery and
0.015 0.003
equipment
Machinery specialised for
0.006 0.008
particular industries
Metal-working machinery 0.002 0.001
Industrial equipment, n.e.s., gen-
eral industrial machinery and
0.036 0.017
equipment, n.e.s., and machine
parts, n.e.s.
Office machines and automatic
0.115 0.087
data-processing machines
Telecommunications and
sound-recording & reproducing 0.038 0.065
apparatus and equipment
Source: Authors’ calculation based on the World Integrated Trade Solution (WITS) database
([Link]/wits/, accessed October 2010).
 Value Chain in the Light Engineering Sector of Bangladesh •3 4 5

Comparative Advantages of Bangladesh’s LEPs in the

South Asian Markets
To estimate the competitiveness of LEPs, revealed comparative
advantage has been estimated for the LEPs at two-three-and four-
digit levels. The results from the estimated RCA for products at the
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two-digit level show that Bangladesh does not have comparative

advantage in LEPs (RCA>1) except a few against those of Sri
Lanka (Table 14.4). Estimates of RCA at three- and four-digit
levels found similar results (see Appendices II and III). At the
three-digit level, Bangladesh’s comparative advantage against
India (RCA>1) lies only on household equipment of base metal
(Standard International Trade Classification (SITC) Code 697.).
With Pakistan, Bangladesh enjoyed high RCA value in the case
of agricultural machinery (excluding tractors) and parts thereof
(commodity 721), textile and leather machinery, and parts thereof,
not specified elsewhere (n.e.s) (commodity 724), articles, n.e.s of
plastic (commodity 893) and miscellaneous manufactured articles
(commodity 899). With Sri Lanka, high RCA has been observed in
the case of articles, n.e.s of plastic (commodity 893) under Division:
89–Miscellaneous manufactured articles, n.e.s.. Bangladesh did
not enjoy comparative advantage over the region in any of the
products either at two-, three- or four-digit levels.

Table 14.4: Revealed Comparative Advantage

(RCA) of LEPs (at two-digit level) in 2007

Code Against Against Against Sri Within South

India Pakistan Lanka Asia
62 0.01 0.01
67 0.04 0.02 9.82 0.23
69 0.29 0.08 0.33 0.26
71 0.03 0.04 0.92 0.05
72 0.18 0.19 0.42 0.18
73 0.24 5.68 0.27
74 0.07 0.00 0.35 0.06
75 0.01 0.00 0.00 0.01
76 0.102 0.00 0.00 0.08
77 0.40 0.03 1.23 0.39
(continued)
 346•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

(continued)

78 0.00 0.00
79 0.06 0.06
81 0.00 0.00
87 0.02 0.01 0.01
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89 0.08 0.420 2.25 0.20

Source: Authors’ calculation based on the World Integrated Trade Solution (WITS) database
([Link]/wits/, accessed October 2010).

A more in-depth observation at the four-digit level also

shows insignificant RCA value for most of the products with
comparative advantages only in one or two products in the case of
Pakistan and Sri Lanka, denoting lack of comparative advantage of
Bangladesh at the regional markets. In other words, Bangladesh’s
light engineering industries are less competitive towards building
linkages with the region.
In general, most of the South Asian countries suffered a
lack of competitiveness in LE products. The poor competitiveness
of South Asian countries is attributed to limited market size,
availability of similar kinds of domestic products, tariff and non-
tariff barriers and low level of price competitiveness.

Analysis of Value Chains of Selected LEPs: Assessing

the Nature and Extent of Regional Linkages
Two light engineering industries, one domestic market-oriented
(razors and razor blades) and the other export market-
oriented (bicycles), have been identified for exploratory analysis
regarding the development of the value chain.

Analysis of the Value Chain of Razors and Razor Blades

Razors and razor blades (commodity 6963: SITC, Rev 3) are man-
ufactured both at public and private sector enterprises in Bangla-
desh. Most of the firms target local markets and one firm exports
razor and razor blades to the Middle East. Compared to other
industries, the per unit value added in razors and razor blades is
low. According to the Survey of Manufacturing Industries (SMI)
2005–6 of BBS, the per unit gross value added in razors and razor
 Value Chain in the Light Engineering Sector of Bangladesh •3 4 7

blades was Tk. 54,950,000 whereas in iron and steel re-rolling

mills it was Tk. 1,034,839,000.
There are a total of four factories in Bangladesh, of which
two are operated under the private sector, one under the public
sector and one is a joint venture. As part of this study, a sample
survey has been carried out in a razor and razor blade factory. This
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factory was established under a joint venture between the gov-

ernment and a foreign-owned company named Wilkinson Sword,
England in 1984 with an initial investment of Tk. 249 million. The
factory had an annual production capacity of 50 million pieces
of razor blades. Since the installation of machineries in 1984,
there has been no restructuring in the factory. Thus, the factory
was faced with problems due to unavailability of spare parts for
installed machineries. With dated technologies and machineries,
the sample firm manufactures about 60 million pieces of blades in
a year. Figure 14.3 represents the value chains of razors and razor
blades for the domestic market.

RAW MATERIALS AND COMPONENT NETWORKS

The sample firm procures the major share of raw materials (e.g.,
acids and chemicals) from local markets. Because of the require-
ment of small amounts of expensive chemicals, procurement from
the local market is considered to be advantageous. However, some
of the intermediate products such as strips, printing ink and a
chemical named Kritox are largely imported from Europe. With
the rise of price of these intermediate products, the sample firm
has increasingly diversified its sources and even shifted to other
regions, such as the South Asian region (e.g., importing blade
strips from India). Another reason for sourcing of raw materials
from India is because of technical compatibility with the require-
ment of local industries.

PRODUCTION NETWORK
According to the management of this factory, the demand for dou-
ble-edged razor blades is declining as it is increasingly replaced
by one-time usable razors. Under this circumstance, the factory
needs to transform its manufacturing base for the production of
one-time usable razor blades. Because of the requirement of sub-
stantial amounts of investment, restructuring and replacing exist-
ing machineries is getting difficult.
 Downloaded by [University of Toronto] at 13:44 15 January 2017

Figure 14.3: The Value Chain of Razors and Razor Blades

Raw Materials
Import from Other
From Local Stage 1 Countries (Names of
Market Shaping- Heat Countries)
Chemical: Treatment
SVP Solvent Intermediate Pakistan, Turkey; UK
Products Coating and
Acid Packaging
From Foreign Stage 2
From Foreign Printing Materials procured
Market
Market from Local Markets
Grinding Wheel:
Blade Strip: India Wrapper
India
Stage 3 Wax paper
Kritox: US Grinding and Stropping Tucks
Printing Ink:
Cello wrapper
US

Final Product
Domestic Market
348•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

Raw Materials Component Production Marketing

Network Network Network Network

Source: Based on the information collected from the interview in November 2010.
 Value Chain in the Light Engineering Sector of Bangladesh •3 4 9

There are concerns with regard to the competitiveness of

this firm, as the industry is heavily burdened in debt. The firm
is unable to supply razor blades at competitive price vis-à-vis
those of imported ones because of the high cost of production
of razor blades. The structure of the cost of production indicates
that over 50 per cent of the total cost of production of blades in
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the sample factory is attributed to the cost of raw materials and

workers’ wages. More importantly, about 11 per cent of the total
cost meets the interest costs of existing and previous debt burdens
(Table 14.5). Unless the firm comes out of debt, it would be difficult
for it to operate competitively even at the local level.

Table 14.5: Cost of Production of Razor Blades in a Sample Firm

Items Share in Total Cost (in per cent)

Cost of raw materials 34.9
Wages and salaries 22.3
Power fuel 4.3
Transport vehicle 0.8
Depreciation cost 6.1
Interest of loans and other charges 11.3
Tax/VAT 2.7
Insurance 0.04
Packaging 8.9
Storage 4.2
For market promotion 4.5
Total 100.0
Source: Based on the survey carried out by CPD in 2010.

MARKETING OF FINAL PRODUCT

The firm sells its total produce to the local market which meets
about 10 per cent of local demand. Retail sales in the local market
ensure a profit margin of Tk. 0.50 from a blade.8 However, this
margin is increasingly becoming difficult to maintain because of
the rising cost of raw materials and workers’ wages. Because of the
liberal tariff structure (12 to 25 per cent of applied tariff) the local
market is getting filled with imported products, mainly from the
products of Pakistan, Turkey and USA. As a result, local firms are
increasingly facing competition with imported products. Import of
 350•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

razor and razor blades has registered a rise in recent years — from
US$ 2 million in 2004 to US$ 2.5 million in 2007 (Figure 14.4).

Figure 14.4: Trade of Razors and Razor Blades with the World

3000
Trade Value (in US$ '000)

2000
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2500
1500
1000
500

0
2000 2001 2002 2003 2004 2005 2006 2007
Import Value
Export Value

Source: Authors’ calculation based on the World Integrated Trade Solution (WITS) database
([Link]/wits/, accessed October 2010).

Export of razors and razor blades is rather very low — in

2007 total export was US$ 365,000.9 There is only one export-
oriented firm in the country which is exporting to the Middle East
market. Within the region, India is the major market for razor
blades with an export of US$ 1.4 million in 2007 followed by
Pakistan (US$ 320,000). There is an increasing trend in export to
both the markets (Table 14.6).

Table 14.6: Export of Razor and Razor Blades from Bangladesh

Country Year Import value(in ’000 US$)

2005 1245.61
India 2006 1295.56
2007 1418.02
2005 152.94
Pakistan 2006 249.01
2007 319.79
Source: Authors’ calculation based on the World Integrated Trade Solution (WITS) database
([Link]/wits/, accessed October 2010).
 Value Chain in the Light Engineering Sector of Bangladesh •3 5 1

Given the challenge faced by the sample firm, there is a

demand for technological upgradation of the manufacturing base.
At the same time, the high debt burden faced by the factory pointed
to weak operation and management capacity of the existing
management. Thus, the firm needs restructuring of the manage-
ment with greater participation of the private sector. This would
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also meet the required capital for technological restructuring of

the firm. A joint venture with domestic firms or with competent
regional firms would contribute to improve the competitiveness of
the firm and would strengthen regional linkages.

Analysis of the Value Chain of the Bicycle Industry

The bicycle industry (commodity 7852: SITC, Rev 3) is one of the
few LEIs of Bangladesh which manufactures for the world market.
Compared to the razor and razor blades industry, the bicycle indus-
try is more exposed to the global market. According to the survey of
manufacturing industries (SMI) 2005–6, there were eight bicycle
manufacturing firms in the country but all of them are not targeted
to export markets.

COMPONENT NETWORK
Unlike razors and razor blades, the bicycle industry uses inter-
mediate inputs which are mostly imported. Table 14.7 shows the
sources of various intermediate inputs — most of these inputs are
sourced from China and Taiwan. The major reasons for depending
upon selected sources are — reasonable price, shorter lead time for
import and acceptable quality.

Table 14.7: Sources of Import of Intermediate Products

Parts Source of Import

Framework Taiwan, China
Paint Taiwan
Handle Bar China
Braking System China, Vietnam, Taiwan
Transmission Japan, Singapore, China, Taiwan
Road Wheel China, Taiwan
Saddle Italy, UK, China
Reflector China
Packaging Materials China
Source: Based on the survey carried out by CPD in 2010.
 352•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

PRODUCTION NETWORK
Most of the local factories are involved in assembling types of
activities. These activities use modern machineries that are mostly
imported. Given the structure of the production process, the indus-
try is yet to be fully automated. The value chain of an industry
manufacturing and exporting bicycles is presented in Figure 14.5.
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Figure 14.5: Value Chain of Bicycle Production

Intermediate Products
from Local Markets
• Fork: (20%) Stage 1
• Handle Bar: (75%) Painting of
Intermediate Products Frame
from Foreign Market
• Frame/Fork: China
(80%) Stage 2
• Paint: Taiwan Wheel
• Handle Bar: China Building Import from Other
(25%)
Countries (Names of
• Braking System:
Countries)
China, Vietnam,
Taiwan India, Pakistan, China
Stage 3
• Transmission: Japan,
Pre-assembly
Singapore, China, Domestic Market
Taiwan
• Road Wheel: Taiwan,
China Stage 4 International Market
• Saddle: Italy, UK (Names of Countries)
Final
(15%) EU, UK, Germany,
Assembly–
• Reflector: China Belgium, Italy, Greece,
Final Product
• Packaging Board: Denmark, Austria, North
China Ireland

Component Production Marketing

Network Network Network

Source: Based on the information collected from the interview in November 2010.

MARKETING NETWORK
Bangladesh exports bicycles to the European market. During FY
2006–7, the total exports of bicycles from Bangladesh was US$ 51
million which was a substantially high amount compared to that
 Value Chain in the Light Engineering Sector of Bangladesh •3 5 3

in 2000–2001 (US$ 10 million) (Figure 14.6). On the other hand,

exports to the regional market are negligible (Table 14.8).

Table 14.8: Trade in Bicycles of Bangladesh with South Asian Countries

Import Value Export Value

Country Year
(US$ ’000) (US$ ’000)
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India 2005 0.06 0.08

2006 0.20
2007 71.18
Pakistan 2007 0.89
Source: Authors’ calculation based on the World Integrated Trade Solution (WITS) database
([Link]/wits/, accessed October 2010).

Figure 14.6: Trend in Export and Import of Bangladeshi Bicycles to World

70000
Trade Value (in US$ '000)

60000
50000
40000
30000
20000
10000
0
2000 2001 2002 2003 2004 2005 2006 2007
Import Value
Export Value

Source: Authors’ calculation based on the World Integrated Trade Solution (WITS) database
([Link]/wits/, accessed October 2010).

According to the local manufacturers, the high price of

locally made good quality bicycles and similarity of products pro-
duced within the neighbouring countries are considered as major
factors for impeding trade within the region. Although manufac-
turers of other regional countries are also the competitors in the
extra-regional markets of South Asia, Bangladeshi manufacturers
retain their markets by supplying better quality products (even at
a higher price).10
 354•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

Challenges for the Development of

Regional Value Chains in the LES
A number of trade and non-trade related barriers hinder the
development of regional value chains in the LES of Bangladesh.
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Tariff Barriers
A number of LEPs are included in the sensitive lists of South
Asian countries under the SAFTA accord. A total of 12 products
out of 1,707 sensitive products of Sri Lanka are LEPs (Table 14.9)
including razors and razor blades and bicycles. Bangladeshi LEPs
are found to be disadvantaged in the Sri Lankan market against
that of India and Pakistan because of MFN rates on Bangladeshi
products. Pakistan’s sensitive list includes four products related to
the LES including bicycles (Table 14.10). As a result Bangladeshi
products face the MFN duty of 35 per cent; on the other hand, Sri
Lanka’s bicycle industry enjoys a preferential tariff of 11.6 per cent
in Pakistan’s market. Thus Bangladeshi products are considered to
be less competitive in the Pakistani market both against local and
Sri Lankan products. India, which is the major trading partner of
LEPs in the region, however, kept out all LEPs from the sensitive
list for LDC members. This has yet to contribute much to enhance
the exports of bicycles there.

Table 14.9: LEPs in the Sensitive List of Sri Lanka

Code Applied Tariffs

40111000 28.0% or 789.66 $/ton whichever is greater
40112000 28.0% or 789.66 $/ton whichever is greater
82121010 15.0%
82121090 28.0%
82122010 15.0%
82122090 28.0%
82129000 28.0%
87060010 2.5%
87060050 15.0%
87120090 28.0% or 6.58 $/units whichever is greater
87150000 28.0%
Source: Based on the data collected from the ITC Trade Map database ([Link]
 Value Chain in the Light Engineering Sector of Bangladesh •3 5 5

Table 14.10: LEPs in the Sensitive List of Pakistan

Code Applied Tariffs

40111000 25.0%
40112010 20.0%
40112090 5.0%
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8712000 35.0%
Source: Based on the data collected from the ITC Trade Map database ([Link]
org/).

Non-tariff Barriers (NTBs)

Machinery, equipments and motor vehicle parts often face NTBs
in the South Asian markets (Moazzem, 2006). Exports of each
specific product from Bangladesh require certain conditions to
be fulfilled.11 According to the stakeholders, LEPs of Bangladesh
mainly face technical barriers in terms of getting certificates for
maintaining standards. The products to be exported to the Indian
market require inspection from the Bureau of Indian Standards
(BIS) before it exports as certificates provided by the Bangladesh
Standards and Testing Institution (BSTI) is not acceptable for
export to India (Rahman et al., 2011). The process of getting the
certificate is both time-consuming and requires resources. Recently,
BSTI in collaboration with BIS has initiated a project to improve
the technical standard of the BSTI and make it compatible for the
Indian market.

Export Similarities
Most of the LEPs manufactured in Bangladesh are also manufac-
tured in other South Asian countries. As a result, Bangladesh has
to compete with other South Asian countries both in regional
markets as well as outside the region, as has been observed
in the case of razors and razor blades and bicycles. India has
export interest to regional markets along with Pakistan and Sri
Lanka to some extent (Table 14.11). Given the export similari-
ties with little linkages in the case of raw materials and compo-
nent networks, there is a scope for weakening the development
of a regional value chain.
 Downloaded by [University of Toronto] at 13:44 15 January 2017

Table 14.11: Export Similarities between South Asian Countries

Razors and Razor Blades Bicycles

Export to SA % of World Export to SA
Exporting Export to World Export to World % of World
Year Region Export to SA Region
Country (in ‘000 US$) (in ‘000 US$) Export
(in ‘000 US$) Region (in ‘000 US$)
India 2005 45440.7 5945.5 13.1 33125.8 2089.6 6.3
2006 51195.1 5523.5 10.8 30031.2 2668.9 8.9
2007 45389.7 5851.5 12.9 22399.9 4147.5 18.5
2008 48707.0 2491.2 5.1 40938.4 5057.8 12.4
2009 48656.3 3147.3 6.5 24139.4 5930.9 24.6
Pakistan 2005 4698.2 247.0 5.3 56.2 51.5 91.6
2006 6039.2 382.1 6.3 72.8 47.8 65.7
2007 6369.1 401.3 6.3 68.1 1.6 2.4
2008 7677.7 458.2 6.0 306.0 246.3 80.5
2009 8644.8 843.1 9.8 NA NA -
Sri Lanka 2005 44.8 3.1 7.0 12073.5 1.9 0.0
2006 536.4 5.2 1.0 19255.9 243.6 1.3
2007 1141.5 19.2 1.7 21333.1 383.9 1.8
356•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

2008 1672.0 3.5 0.2 36594.0 622.6 1.7

2009 300.5 5.4 1.8 47650.6 490.3 1.0
Source: Authors’ calculation based on UN Comtrade dataset.
 Value Chain in the Light Engineering Sector of Bangladesh •3 5 7

Obstacles in Intra-regional FDI

Flow of foreign direct investment (FDI) in the LES of Bangladesh
is very limited. The only two industries that received FDI are metal
and machinery products and vehicle and transport equipments.
There was no FDI flow from the South Asian countries in vehicle
and transport equipments (Table 14.12).
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Table 14.12: Inflow of FDI in Bangladesh in Metal and

Machinery Industries (in US$ Millions)

Country 2002 2003 2004 2005 2006 2007 2008 2009

India 0 (0%) 0(0%) 0(0%) 0(0%) 0(0%) 0(0%) 0(0%) 0.26 (19.4%)

Pakistan 0 (0%) 0 (0%) 0(0%) 0(0%) 0(0%) 0(0%) 0(0%) 0.18 (13.4%)
0.3 0.07 0.67 0.06 0.01 0.01 0.02 0.9
Others (100%) (100%) (100%) (100%) (100%) (100%) (100%) (67.2%)
Source: Based on the data collected from the Bangladesh Bank website ([Link]
[Link]/, accessed 21 August 2012).
Note: Other countries include UAE, UK, Singapore, Japan, South Korea, Taiwan, Canada, Hong
Kong, and British Virgin Islands.

However, uncertainties regarding supply of raw materials,

availability of gas and electricity, high-end product development,
investment security and other facilities constrain investment in
the LES. The stakeholders’ opine that both joint ventures and
100 per cent foreign investment would be beneficial mainly for
manufacturing specialised and finished products for the sector.

Other Constraints
The light engineering industries of Bangladesh are constantly facing
the problem of lack of state-of-the-art technologies. According to the
BEIOA officials, while fifth-generation technologies are used in the
LEIs, Bangladesh still uses second-generation technologies. Because
of the technological constraint, sometimes local products can not
compete with the foreign products, particularly in terms of outer look
and finishing (DCCI, 2005). Besides, lack of skilled and experienced
personnel (e.g., programme operators) for operating high-quality
machineries is another constraint for the development of the LES. In
the absence of upgrading the curriculum of the professional institutes,
colleges and universities, students passing out from these institutes
lack recent and latest technological knowledge and technical know-
how which are required for the light engineering industries. As a
 358•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

result, light engineering firms have to provide in-house training to the

workers/professionals after hiring them.
Information gaps remain in this sector as the bankers
and lease financers are not well aware about the sector which
discourages them to finance such projects. On the other hand,
manufacturers do not get sufficient information with regard to
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demand of their products in the foreign markets, sources of raw

materials and intermediate products.
In general, the development of the LEIs of Bangladesh has
faced internal and external challenges. On the one hand, most of
these industries operate with a traditional technological base and
semi-skilled workers that are found to be less competitive in many
instances. With such a weak level of competitiveness, it is difficult
to penetrate regional markets except for sourcing raw materials
and intermediate inputs. Moreover, a strong competitive industry
as exists in a few cases need not necessarily help to develop strong
regional linkages because of the persistence of various bottlenecks
in the case of regional market access.

Concluding Remarks: Recommendations

The regional value chain in the LES of Bangladesh is still
underdeveloped. To initiate the process, local LEIs have to develop
their competitiveness first for the domestic market and then for
export markets. For improvement of technological bases, industries
across the board need support for making available technical
know-how currently available in developed and developing
countries. A large part of the local industries need upgradation of
skills of professionals and workers. In order to ensure a balanced
development of LEIs, a specialised industrial park needs to be
set up with sufficient plots, infrastructure, banking, and other
logistic facilities, etc. In the next stage, a number of initiatives are
required to develop horizontal and vertical linkages of the value
chains of the light engineering industries within the region. This
includes taking out LEPs from the sensitive lists, identifying NTBs
and withdrawing these NTBs, development of trade facilitation
measures at border points, increasing intra-regional investment
in joint venture projects, taking initiatives for harmonisation of
standards and mutual recognition of standards, etc.

Y
 Value Chain in the Light Engineering Sector of Bangladesh •3 5 9

Notes
1. According to the UN Statistics Division, major LEIs under SITC two-
digit level are: 62: Rubber Manufacturers; 67: Iron and Steel; 69: Man-
ufactures of Metals; 71: Power Generating Machinery and Equipment;
72:Machinery Specialised for Particular Industries; 73: Metalworking
Machinery; 74: General Industrial Machinery and Equipment and
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Machine Parts; 75: Office Machines and Automatic Data-processing

Machines; 76: Telecommunications and Sound-recording and Repro-
ducing Apparatus and Equipment; 77: Electrical Machinery, Appara-
tus and Appliances and Electrical Parts (including non-electrical coun-
terparts, of electrical household-type equipment); 78: Road Vehicles
(including air-cushion vehicles); 79: Other Transport Equipments;
81: Prefabricated Buildings; sanitary, plumbing, heating and lighting
fixtures and fittings; 87: Professional, Scientific and Controlling Instru-
ments and Apparatus; 89: Miscellaneous Manufactured Articles.
2. There is no universal definition for the LES. There are variations
among countries regarding the product line of the sector.
3. According to the Census on Manufacturing Enterprises (CMI), 2005–
6, per unit gross value added by the industry of iron and steel mills
was the highest (Tk. 1830.5 thousand), followed by iron and steel re-
rolling mills, bicycles, manufactures of rubber products, etc. The LEIs
are mostly labour-oriented, where number of male labourers consti-
tutes more than 50 per cent of the workforce in most of the industries.
4. Theoretically a value chain encompasses a large constellation of ac-
tivities that are embodied in a production network that add value to
the final product.
5. As per the interview of the president of BEIOA, Mr Abdur Razzaque,
published in the Daily Prothom Alo on 7 January, 2011.
6. The G-L index shows the ratio of intra-industry trade to total trade.
7. The pure G-L index is multiplied by the weight of the industry to do a
better evaluation on the intra-industry trade.
8. Because of increasing cost of production without any upward revision
of the retail price of the razor blades, the profit margin is gradually
decelerated.
9. Due to the unavailability of sufficient data from the perspective of
Bangladesh, estimation of RCA and intra-industry trade has not been
possible. In some cases, to get a picture on the trade, mirror data of
other countries are used.
10. According to local exporters, bicycles manufactured in India are
priced 32–34 Euros in the European market, whereas bicycles from
Bangladesh are priced at 68 Euros. Even then, local manufacturers
and exporters of bicycles opined that they have huge potential in the
EU market.
 360•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

11. For example, India imposed different kinds of NTBs on various prod-
ucts including food items, jute goods, Jamdani sarees, and cement.

References
Athukorala, P. 2006. ‘Product Fragmentation and Trade Patterns in East
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Asia’, Asian Economic Papers, 4(3): 1–27.

Athukorala, P. and N. Yamashita. 2006. ‘Product Fragmentation Trade
Integration: East Asia in Global Context’, North American Journal of
Economics and Finance, 17(3): 233–56.
BBS. 2010. ‘Report on Bangladesh Survey of Manufacturing Industries
(SMI) 2005–06’, Bangladesh Bureau of Statistics, Planning Division,
Ministry of Planning, GOB, August.
DCCI. 2005. ‘Economic Policy Paper on Light Engineering & Electronics
Enterprise in Bangladesh’, prepared under the DCCI-CIPE/ ERRA Project,
The Dhaka Chamber of Commerce and Industry (DCCI), Dhaka.
ITC. 2008. ‘A Strategy for Developing the Light Engineering Sector in
Bangladesh’, Bangladesh Quality Support Programme Component 2 (A
project funded by European Union), August, International Trade Centre,
Geneva.
Maxwell Stamp Ltd. 2009. ‘Towards an Evidence Base for Efficient,
Proactive and Inclusive SME Development: Case of Light Engineering
Sector of Bangladesh’, a report submitted to the Ministry of Industries,
GoB by Maxwell Stamp Ltd., 16 April, Dhaka.
Moazzem, K. G. 2006. ‘Liberalising Trade under SAFTA: The Issue of Non-
Tariff Barriers’, paper presented in Advanced Training Course on WTO and
Bangladesh Trade Policy Centre for Policy Dialogue (CPD), Dhaka.
Organisation for Economic Cooperation and Development (OECD). 2007.
‘Enhancing the Role of SMEs in Global Value Chains’, OECD Background
Report, OECD Global Conference, Tokyo, 31 May–1 June.
Rahman, M., T. I. Khan, A. Nabi and T. K. Paul. 2011. ‘Bangladesh’s Export
Opportunities in the Indian Market: Addressing Barriers and Strategies for
Future’, South Asia Economic Journal, 12(1): 117–41.
Sakai, K. 2002. ‘Global Industrial Restructuring: Implications for Smaller
Firms’, STI Working Paper 2002/4, OECD, Paris.
Sturgeon, T. J. 2001. How Do We Define Value Chains and Production
Networks? Industrial Performance Center, Massachusetts Institute of
Technology, April.
 Value Chain in the Light Engineering Sector of Bangladesh •3 6 1

Appendices
Appendix I: RCA of Bangladesh’s LEPs against South Asian Countries,
2007 (at three-digit level)

Country Product Code RCA

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India 691 0.471

692 0.046
693 0.000
694 0.000
695 0.058
696 0.027
697 2.218
699 0.517
Pakistan 721 41.912
724 28.925
892 0.037
893 1.957
894 0.112
899 11.234
Sri Lanka 892 0.797
893 8.521
South Asia 691 0.368
692 0.034
694 0.010
695 0.123
697 0.679
699 0.438
Source: Authors’ calculation based on the World Integrated Trade Solution (WITS) database
([Link]/wits/) accessed October 2010.
 362•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

Appendix II: RCA of Bangladesh’s LEPs against South Asian Countries,

2007 (at four-digit level)

Country Product Code RCA

India 692.4 0.159
697.4 0.015
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Pakistan 724.4 28.412

724.6 0.051
724.9 0.008
893.3 0.025
899.1 18.431
Sri Lanka 674.1 176.179
893.1 0.003
893.9 19.620
South Asian Region 691.1 0.393
693.1 0.000
Source: Authors’ calculation based on the World Integrated Trade Solution (WITS) database
([Link]/wits/) accessed October 2010

Appendix III: Weighted GLI of LEIs (at three-digit level) between

Bangladesh and Sri Lanka

Product Code Year GLI Product Code Year GLI

674 2006 0.000 2005 0.000
752
676 2005 0.000 2006 0.000
695 2007 0.000 759 2005 0.000
697 2005 0.000 771 2006 0.000
2005 0.000 2005 0.000
699
2007 0.000 775 2006 0.000
2005 0.000 2007 0.000
724 2006 0.003 2005 0.000
2007 0.000 778 2006 0.001
726 2006 0.000 2007 0.005
728 2007 0.011 793 2006 0.000

(continued)
 Value Chain in the Light Engineering Sector of Bangladesh •3 6 3

(continued)
2005 0.000 2005 0.000
741 2006 0.000 892 2006 0.001
2007 0.000 2007 0.003
743 2007 0.000 2005 0.003
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2005 0.000 893 2006 0.009

744 2006 2007 0.003
2007 0.002 899 2005 0.002
2005
749
2006 0.000
Source: Authors’ calculation based on the World Integrated Trade Solution (WITS) database
([Link]/wits/) accessed October 2010

Appendix IV: Weighted GLI of LEIs (at three-digit level)

between Bangladesh and India

Product Code Year GLI Product Code Year GLI

671 2006 0.000 749 2007 0.000
676 2007 0.001 763 2007 0.000
679 2007 0.000 764 2007 0.000
691 2007 0.001 771 2007 0.002
692 2007 0.000 772 2007 0.000
693 2007 0.000 773 2007 0.000
694 2007 0.000 774 2007 0.000
695 2007 0.000 775 2007 0.000
696 2007 0.000 776 2005 0.000
697 2007 0.000 778 2007 0.005
699 2007 0.001 781 2007 0.000
724 2007 0.002 782 2007 0.000
725 2007 0.000 786 2007 0.000
726 2007 0.000 791 2006 0.000
727 2006 0.000 792 2007 0.000
728 2007 0.001 793 2007 0.000
741 2007 0.000 813 2006 0.000

(continued)
 364•Khondaker Golam Moazzem and Mehruna Islam Chowdhury

(continued)
742 2007 0.000 892 2007 0.000
743 2007 0.000 893 2007 0.000
744 2006 0.002 894 2007 0.000
745 2007 0.000 895 2007 0.000
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746 2007 0.000 896 2007 0.000

747 2007 0.000 897 2005 0.000
748 2007 0.000 899 2007 0.000
Source: Authors’ calculation based on the World Integrated Trade Solution (WITS) database
([Link]/wits/) accessed October 2010

Appendix V: Weighted GLI of LEIs (at three-digit level)

between Bangladesh and Pakistan

Product Code Year GLI Product Code Year GLI

694 2005 0.000 2005 0.000
2006 0.001 775 2006 0.000
696
2007 0.001 2007 0.000
2005 0.000 2005 0.000
697 2006 0.000 778 2006 0.000
2007 0.000 2007 0.000
2005 0.000 792 2006 0.000
699
2007 0.000 2005 0.001
721 2007 0.000 892 2006 0.000
2005 0.001 2007 0.000
724 2006 0.001 2005 0.008
2007 0.001 893 2006 0.005
727 2007 0.000 2007 0.002
728 2007 0.001 2005 0.000
894
741 2007 0.000 2007 0.000
744 2006 0.000 2005 0.000
749 2005 0.000 899 2006 0.001
772 2006 0.000 2007 0.000
Source: Authors’ calculation based on the World Integrated Trade Solution (WITS) database
([Link]/wits/) accessed October 2010
 About the Editor
Shahid Ahmed is Professor at the Department of Economics and
Director of the Centre for Jawaharlal Nehru Studies, Jamia Mil-
lia Islamia, New Delhi. Earlier, he served as Consultant, Econo-
mist and Senior Economist at the United Nations Conference on
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Trade and Development (UNCTAD) India Programme, New Delhi.

Dr Ahmed has more than 16 years of teaching and research expe-
rience in economics, particularly econometrics, macroeconomics,
international finance and international trade. He has also worked
extensively on policy-related issues and provided technical ad-
vice to the Department of Commerce, Government of India with
respect to bilateral and multilateral trade negotiations. He has
published an edited book and more than 40 research papers in the
areas of trade, development, finance and regional trading blocs. He
specialises in econometrics and computable general equilibrium
modelling. His present research broadly deals with Free Trade
Areas, World Trade Organization negotiations and Foreign Direct
Investment.
 Notes on Contributors
Sarah Ahmed is Associate Professor at the Department of
Economics, Faculty of Arts, Maharaja Sayajirao University, Baroda
(Vadodara). She has about 29 years of experience in teaching and
research. She has published papers in research journals, edited
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books and has undertaken research projects funded by various

agencies. Her areas of interest are agricultural economics, natural
resources and environmental economics and economics of growth
and development.

Mehruna Islam Chowdhury is Research Associate at the Centre

for Policy Dialogue (CPD), Bangladesh. She has completed her
M.A. in Development Studies from the North South University
and M.A. in Economics from the National University, Bangladesh.
During her tenure at the CPD, she worked on a number of issues
including development of a framework for a comprehensive trade
policy for Bangladesh, and regional cooperation in South Asia,
and has a number of publications related to the fields of trade,
industry and agriculture. Her major areas of interest include trade,
investment and the industrial sector of Bangladesh.

Jayesh N. Desai is In-charge Director of BRCM College of Business

Administration affiliated to Veer Narmad South Gujarat University,
Surat. Dr Desai’s research interests are international trade, trade
in services, studying country competitiveness and international
outsourcing of services.

Tanu M. Goyal is Research Associate at the Indian Council for

Research on International Economic Relations (ICRIER), New
Delhi. She has an M.A. degree in Economics with specialisation in
world economy from the Centre of Trade and Development (CITD),
Jawaharlal Nehru University, New Delhi. Her research interests
include trade in services, foreign direct investment issues and retail.
She has worked on projects sponsored by the Indian government,
foreign trade commissions, and international organisations like the
Asian Development Bank (ADB), among others. She has published
international journal articles, several book chapters, reports and
other popular articles on policy and trade issues.
 Notes on Contributors •3 6 7

Neha Gupta is a Ph.D. scholar in Economics at the Department

of Humanities and Social Sciences, Indian Institute of Technology,
Delhi. She is working on the integration of India’s manufacturing
sector into global supply chains. Earlier, she worked at the
Federation of Indian Chambers of Commerce and Industry (FICCI),
New Delhi for more than two years. She has presented her research
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in national and international conferences.

Sudakshina Gupta is Associate Professor at the Department of

Economics, University of Calcutta. She has published more than
15 research papers in reputed national and international journals
and has authored a book.

Harish is Associate Professor of Economics at the Department of

Economics, B. R. Ambedkar College, University of Delhi. She has
two books and several research papers to her credit. Her main
areas of research are macroeconomics, development economics,
growth and issues related to social development.

Tran Van Hoa holds higher academic degrees from the University
of Western Australia and Monash University, Victoria, Australia,
and has taught widely at universities in Australia, Asia and the
US. He has trained government officials and business executives in
market economics, trade, development and competition policy and
business economics in major Asian countries. He has published over
220 refereed papers and commissioned reports and 26 books in
the major applied and theoretical areas of economics, international
trade, econometrics, development economics, finance, climate
change, energy and competition policy.

Md. Saiful Islam is Professor of Economics at Khulna University,

Khulna, Bangladesh. He completed his Ph.D. in Development
Finance from Niigata University, Japan. He has 18 years of
teaching and research experience at several leading universities
in Bangladesh, and has served as Dean, Faculty of Social Science,
and Chairman, Department of Economics. He has 45 international
publications.

Sushil Kumar is pursuing his Ph.D. in Economics from the Depart-

ment of Economics, Jamia Millia Islamia, New Delhi. Earlier he
 368 •Notes on Contributors

served as Research Fellow in Economics at the Haryana School of

Business, Guru Jambeshwar University of Science and Technology
(GJUS&T), Hisar, Haryana. He also served at Amity University as
visiting faculty member. His research interests are international
trade and finance.
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Nabeel A. Mancheri is an economist by training with specialisation

in India’s economic relations with East Asia and Australia. His
research interests are in international economics, international
political economy, strategic economics, energy and natural
resources management. He currently teaches at National Institute
of Advanced Studies, Bangalore. Previously, he has been associated
with the Organisation of Economic Cooperation and Development
(OECD) Paris, Indian Council for Research and International
Economic Relations (ICRIER), New Delhi and the Consumer Unity
and Trust Society (CUTS) International on research related to
trade issues.

Syed Imran Ali Meerza served as a part-time faculty member in

Economics, Khulna University, Khulna, Bangladesh. He did M.S.S.
in Economics from North South University, Dhaka, Bangladesh.
Presently he is pursuing his Ph.D. from the Department of Econom-
ics at South Dakota State University, USA.

Bikash Ranjan Mishra is Lecturer in the Department of Economics

at Ravenshaw University, Odisha. He has recently submitted his
Ph.D. thesis at the Department of Humanities and Social Sciences
of the Indian Institute of Technology, Kanpur. His research interests
lie in foreign direct investment and its spillover effects, and the
mode of foreign market operation. He has also been involved in
the productivity analysis of Indian manufacturing firms.

Khondaker Golam Moazzem is a an industrial economist. Cur-

rently he is working as Senior Research Fellow at the Centre for
Policy Dialogue (CPD), Bangladesh. Dr Moazzem holds a Ph.D. in
Development Economics from Kyoto University, Japan. His major
areas of interest include the analysis of the global value chain in
the manufacturing sector, development of small and medium enter-
prises (SMEs), entrepreneurship development, trade-related issues
of the industrial sector and competition policy, etc. He has published
a number of articles in journals and co-authored several books.
 Notes on Contributors •3 6 9

Peter J. Morton is Professor at the Department of Economics and

the Language Center, Chinese Culture University in Taipei, Taiwan.
His research interests include macroeconomic consequences
of labour compensation schemes, historical rates of return on
sovereign lending, trade and investment flows in the Asia-Pacific
region, and statistical analysis of academic writing.
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Arpita Mukherjee is Professor at Indian Council for Research and

International Economic Relations (ICRIER), New Delhi. She has
several years of experience in policy-oriented research working
closely with the governments in India and the UK. Her research is
a key contributor to India’s negotiating strategies in the ongoing
Doha Round of WTO negotiations and India’s bilateral agreements.
Her research has contributed to India’s domestic policy reforms in
the services sector. Dr Mukherjee has a Ph.D. in Economics from
the University of Portsmouth, UK. She has over 60 publications
including books, journals, working papers and government reports.

Ishita Mukhopadhyay is presently Professor at the Department

of Economics, University of Calcutta. She is also the Director of
Women Studies, University of Calcutta. She has published more
than 50 research papers in reputed national and international
journals in the fields of optimisation technique, labour economics,
gender and development issues, etc.

Subir Kumar Sen is Assistant Professor at the Department of

Commerce, Tripura University, Agartala. He is pursuing his Ph.D.
from the Department of Economics, University of Calcutta. Mr
Sen has already completed one minor research project funded
by the University Grants Commission (UGC), New Delhi. He has
published two papers in publications of international repute.

Suman Sharma is Research and Teaching Assistant at the Faculty

of Economics, School of Social Sciences, Indira Gandhi National
Open University (IGNOU), New Delhi. She has been attending
various conferences in India and sharing her views on various
issues related to her discipline. Currently she is working on her
doctoral research work.
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 Index
academic mobility, 235 integration policy analysis,
active pharmaceutical ingredients 32–36; substantive findings and
(APIs), 167 their policy modelling realism
Additive Outlier (AO) model, 167 properties, 36–39
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‘Adjustment of Retail Business Asia economic crisis (1997), 30,

Operations of Large-Scale Retail 40
Stores,’ 56 Asian Development Bank (ADB),
Agartala: transhipment route from 25, 36, 366
Kolkata Port to, 292 Asian emerging market index, 186
Agricultural Produce Marketing Asian Highway Network (AHN),
Committee (APMC) Act, 51 282, 290–91
Agro-climatic Planning and Asian stock indices, 187
Information Bank, 89 Asia-Pacific Economic Co-
agro-processing industry, FDI in, operation (APEC), 27, 32, 337
82 Assam–Agartala road see National
Akaike Information Criterion Highway-44 project
(AIC), 104, 107, 131, 157 asset markets, 188–203
Almaty Conference (2003), 285, asset price, 189, 195, 201
287 Association of South East Asian
anti-competitive policy, 59 (ASEAN), 25–27, 29–41, 337
ASEAN Free Trade Agreement A T Kearney’s Services Location
(AFTA), 25–26, 320 Index, 18
ASEAN-friendly Treaty of Amity Augmented Dickey Fuller (ADF)
and Cooperation, 27 test, 104, 129Australia:
ASEAN–India trade and economic bilateral service trade, by India,
growth, 32–33; contribution 216; higher education industry
to India’s growth, 39–40; in, 241; RCA indices for, 220;
domestic reforms and regional service exports, to India, 219
shocks, role of, 42; ‘economic Australian Bureau of Statistics
diplomacy,’ implications for, 43; (ABS), 219
factors governing, 40; FDI and autoregressive distributed lag
services, importance of, 41–42; model (ARDL), 159
globalisation and regional
geopolitical competition and Balance of Payment Manual (IMF),
trade agreements, implications 114
for, 43; growth regression vs balance-of-payments (BoP), 26, 114
flexible EGT simultaneous- banking: OECD Secretariat
equation modelling, 40–41; assessed barriers in, 227; TRI of
implications for, 39–43; ‘Look India for, 228
East’ policy, implications business-to-business (B2B)
for, 43; model for economic e-commerce, 52
 372 •Index

Centre for Monitoring Indian domestic regulation, 226 see also

Economy (CMIE), 175 Service trade, in India
Centres for Excellence for Precision door-to-door selling, 56
Farming (CEPFs), 89–90 dynamic intertemporal general
collective ability, of firms, 263–64 equilibrium model, 210 see
Colombo Plan, 254 see also also Computable general
International higher education equilibrium (CGE) model
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service, in Australia
communication technologies: East Asia Economic Model, 41
impact of, 192 East Asia Summit (EAS), 25–27,
Competition Act (2002), 77 337
Comprehensive Economic e-commerce, 52
Partnership Agreement (CEPA), economic activity: distribution of,
211–12; liberalised access for 189–90
Indian professionals, by Japan, Economic and Financial
212 Partnership (2010), 212
computable general equilibrium ‘economic diplomacy,’ 25–26,
(CGE) model, 33, 210 31–32, 39, 42
computer and information services economic growth, in selected
(CIS), 18; export and import South Asian countries:
performance of countries in, cointegration and Johansen test
265; movements in world for analysis of, 104–5; data and
market share, 276–78; relative methodology for estimating
trade performance during 2000 impact of FDI, 103–5; DF/ADF
and 2008, 267; trade growth unit root tests for Bangladesh,
rates in, 266; world market India, and Pakistan, 106;
share of countries in, 275 empirical results for analysis of,
Concurrent List, 51 106–9; Granger causality test
Confederation of Indian Industry for analysis of, 105; Johansen
(CII), 59 and Juselious cointegration
consultancy services, 85, 89 tests for analysis of, 107–8; unit
cost of education, 251–52 root test for analysis of, 103–4
crop yield monitoring, 90 economic interdependence:
cross-border education, 236, 251 determinants of, 191
cross-border supply, 2 economic liberalisation: in India,
189
departmental stores, 59 economic need test (ENT), 56
Department of Industrial Policy Economic Partnership Agreement
and Promotion (DIPP), 48, 54, (EPA), 218
58, 76, 113 Economic Partnership Agreement
deregulation: impact on India’s (EPA)/CEPA: agreement between
service sector, 228–29 India and Japan in 2011, 212
Doha Round, 32, 210 see also economy, Indian: restructuring in
Preferential trade agreements early 1990s, 213
(PTAs) education exchange, 235
 Index •3 7 3

education services: imports of, evidences, 122; theories

240–41; (by India), 245; trade assuming imperfect markets,
in, 235 117–19; theories assuming
electronics-based information: perfect markets, 116–17; time
impact of, 192 series modelling approaches,
endogenous growth-trade theory comparison of, 126; variance
(EGT), 32–33; modelling decomposition method for
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performance of ASEAN–India analysis of, 128–29

trade, Friedman-Kydland Federation of Indian Chambers
Criterion, 39; modelling of Commerce and Industries
performance of India’s growth, (FICCI), 59
Friedman-Kydland criterion, 38 final prediction error (FPE), 132
Engle cointegration causality, 33 financial crisis: US housing prices,
equity capital, 1, 115–16 186
exchange-traded funds (ETFs), financial decoupling, 186;
188 see also Decoupling evidence for, 194–201; origin
export-led growth hypothesis of, 188–93
(ELGH), 101–3 food retailing, 59
Export Promotion Capital Goods foreign direct investment
(EPCG) Scheme, 318 (FDI): accounting in India,
exports of goods and services 115–16; in agriculture, 93;
(EXPs), 122–23 barriers to free flows of, 4;
benefits of, 3; characteristics
Factor-Proportions Hypothesis, 119 of, 3; components of, 1,
farm management system, 82 115; confidence index, 92;
FDI determinants, theory determinants of (see FDI
and evidence of: data and determinants, theory and
methodology for analysing, evidence of); for e-commerce
122–25; differential rates activities, 52; effect on
of return, 116–17; eclectic domestic investment, 81; IMF–
approach, 118–19; econometric OECD definition of, 114–15;
methodology for analysis of, impact on economic growth,
123–25; export-platform, 120; 1, 146; linkages with services
impulse-response functions, trade, 1–2; literature review
127–28; industrial organisation and existing views on, 57–60;
and oligopolistic reaction, meaning and measurement
117; internalisation issues, of, 114–16; new trade theory,
118; knowledge-capital model, 119–20; Porter’s generic value
120; market size, 117; model chain model, 2; in precision
specification for analysis agriculture (see precision
of, 123; new trade theory, agriculture (PA)); for retail
119–20; other country-specific sector in India, 74–77; sectoral
determinants, 120–21; portfolio distribution of, 5; as strategy
diversification, 117; product to promote internationalisation
life cycle, 118; some empirical of activities, 2; survey design
 374 •Index

and research methodology in generalised method of moments

retail sector, 60–62; variance (GMM), 35
decomposition of, 136–37; geographical information system
worldwide flow of, 3–7 (GIS), 83, 85
foreign equity, 56 global commodity chains (GCCs),
Foreign Exchange Management Act 303–4
(FEMA), 1999, 317 Global Education Digest, 246
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Foreign Exchange Regulation Act global financial crisis (GFC), 25,

(FERA), 1973, 317 32
Foreign Investment Promotion global positioning system (GPS),
Board (FIPB), 52, 239 83, 85, 89–91
foreign retailers, mode of entry global production networks
and present mode of operation (GPNs), 18, 303–4; Indian
of, 53 industries negligible integration
Foreign Trade Policy (FTP), 2009– into, 306; successful formation,
14, 318 in East Asia, 319–28
fragmentation theory: simple global service trade: India status
version of, 305; two- in, 213–16
dimensional, 306; (cost global supply chains (GSCs),
structure in), 307 303–4
Framework for Cooperation on global trade analysis project
Trade and Investment (2009), (GTAP), 33, 35, 40, 42, 210
212 global value chains (GVCs), 12–13,
freedom of transit, 287 18–19, 303
free trade, 209 Granger cointegration causality
free trade agreements (FTAs), 31, test, 33, 132–33, 149; for
47 see also Preferential trade Bangladesh, 108; for India,
agreements (PTAs); ASEAN– 109; for Pakistan, 109; Toda
India, 26; aspects of, 209; Yamamoto version of, 144
Australia and India agreement gravity model approach, 148, 210
in 2008, 212; empirical see also Free trade agreements
assessment of, 210; India–Sri (FTAs)
Lanka, 26; India–Thailand, 26; gross domestic capital formation
regional trade agreements, 210 (GDCF), 122–23
gross domestic product (GDP), 9,
GATS-plus, 213 47, 102–3, 122–23, 131
GATT, 204, 226, 261, 287 Grubel-Lloyd (GL) index, 18, 224,
General Agreement on Trade in 316, 342–43
Services (GATS), 2, 226–27;
Article V of, 211, 287–88; Haavelmo’s economy-wide
commitment of India, on higher transmission mechanism, 35
education under, 238–40; Hannan-Quinn information
liberation of education services, criterion (HQ), 131
as service sector, 236 Heckscher-Ohlin model, 261
 Index •3 7 5

Heckscher-Ohlin-Samuelson from FDI, 170–71; positive

framework, for analysing productivity spillover through
impact of FDI on economic competition, 171–72; research
growth, 146 and development (R&D)
Herfindahl–Hirschman Index expenditure, 171
(HHI), 179 Indian Space Research
higher education services: export Organisation, 89
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revenue of: (Australia, 235; India’s trade relations with Asia:

India, 235; United States, 235); ASEAN–India trade growth
volume and composition of and share, 30; Comprehensive
flow of services, 240–45 Economic Cooperation
higher education system: under Agreement with Singapore,
GATS and India’s commitments, 26; major partners of, 26–30;
238–40; in India, 255; regional economic integration
(hurdles in promotion, 237; policy and external relations,
low expenditure per student, 39–43; top 10 export
235–36); standard of higher destination shares, 28; top 10
education institutes, 237 export destination trend, 27;
horticulture, 84–86 top 10 import source shares,
hypermarkets, 59 29; top 10 import source trend,
28; trends and major features
ICT-enabled services, 261 of, 26–30; world trade partner
Import Export Policy, 1990–93, 318 shares, 29
impulse response functions (IRF), indices of a service: definition of,
127–28 220
IMSjt, 246 information and communication
India–Bangladesh relation: and technology (ICT), 3; ‘splinter
transhipment route issue for off’ services, 260
Northeastern region, 288–95 information technology (IT), 84
India–Japan FTA: economic Innovational Outlier (IO) model,
impacts of, 210 155
Indian Council for Research Institute for Statistics, 246
on International Economic insurance: TRI of India for, 228
Relations (ICRIER), 60 intellectual property rights (IPRs),
Indian pharmaceutical industry, 96
166–67; foreign direct international higher education
investments in, 167; foreign- service: in Australia, 254
owned firms, 169–70; model international investors, 186
estimation and analysis internationalisation, of education,
of results, 175–82; model 236
specification, estimation international production network
techniques and data sources for (IPN), 305
examining FDI inflows, 172–75; international student mobility
positive productivity spillover (ISM), 243
 376 •Index

intra-firm loans, 1 and razor blades, analysis of,

intra-firm trade, 12; cross-border, 346–51); South Asian markets,
2 advantages of, 345–46
intra-industry trade (IIT), 303, light engineering sector (LES),
316–17; regional value chain Bangladesh, 336; challenges for
of light engineering products, development of regional value
current state of, 343–44 chains in: (export similarities,
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intra-industry trade indices, 355–56; intra-regional FDI,

223–24 obstacles in, 357; non-tariff
intra-regional trade intensity, barriers (NTBs), 355; tariff
191–92 barriers, 354–55); methodology
inward foreign direct investment of study, 342–43; value chain
(IFDI), 247 of, generic structure, 338;
(production and marketing
Japan: bilateral service trade, by of products, 340–41; raw
India, 216; collapse of asset materials procurement and
bubble in 1980s, 193; economic processing, 339–40)
dominance of, 190–91; RCA livestock rearing, 85
indices for, 220–21; total ‘Look East’ policy (India), 25–26,
market capitalisation decline, 31–32, 39, 42; implications for,
194 43
Joint Study Group (JSG) report,
212 machinery sector, in India: extent
joint ventures, 52–53, 64, 76 of integration of: (India and
other countries, 308–14; India’s
Kolkata Port: to Agartala, position (1990-2009), 314–16;
transhipment route, 293 intra-industry trade (IIT), India,
316–17; policy framework,
labour-intensive industries, 12 317–18)
landlocked developing countries machinery trade: of China, 321; of
(LLDC), 284; disadvantages of, Malaysia, 322–23; of Thailand,
284–85; freedom of transit for, 323–24
287; trades in, 285 market access restrictions, to FDI,
least developed countries (LDCs), 4
18, 284–85, 303 Marks & Spencer, 70
light engineering industries (LEIs), Marshall’s economy-wide
Bangladesh, 336 transmission mechanism, 35
light engineering products (LEPs), maximum likelihood estimation, 35
19, 339–42; current state Memorandum of Understanding
of regional value chain of, (2010): between India and
343–44; nature and extent of Bangladesh, 283 (see also
regional linkages, assessment Tripura government, demand
of: (bicycle industry, analysis of, for transit route through
351–53; value chain of razors Bangladesh)
 Index •3 7 7

merger and acquisition, 1 outward foreign direct investment

Morgan Stanley Far East Index, 197 (OFDI), 247
M. S. Swaminathan Research overseas students: policy in
Foundation, 89 Australia, 254
multi-brand retail, 76
multilateral trading system, 32 Pantaloon Retail Limited, 50
multinational companies (MNCs), Perron 97 unit root test, 153
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3, 116, 168 Phillips-Perron test, 129

multinational enterprises (MNEs), Planning Commission, 89
113; investment portfolio of, Porter’s generic value chain model
117; role in electrial machinery for investments, 2
and automobile industries, 308; precision agriculture (PA): case
subsidised loans to attract, 121 study for application of,
Mutual Recognition Arrangement 90–91; concept of, 83, 85;
(MRAs), 211–12, 218 contribution of technology
for higher yields in, 91; farm
National Highway-44 project, 281 management technology, 93;
National Horticulture Mission, 86 foreign collaboration for in,
National Research Committee 89; importance in the Indian
(NRC), 87 economy, 82–84; linking FDI
National Retail Act, 59 and implementation of, 85–86;
National Sample Survey prospects of FDI in, 86; role
Organisation (NSSO), 48 of FDI in promoting, 91–95;
negative agglomeration, 306 sectors attracting highest FDI
new economic geography theory, equity inflows, 94; statement
306 on sector-wise FDI inflows,
newly industrialised countries 95; use of ‘soft’ and ‘hard’
(NICs), 189–90 technology for, 88
new regionalism, 209 Precision Agriculture Simulation
Non-Aligned Movement (NAM), 26 and Investment Model (PASIM),
Northeastern Region: 88
transhipment route issue for, Precision Farming Development
288–95 Centres (PFDCs), 89
preferential trade agreements
‘OLI’ advantages and MNC (PTAs), 226–27 see also Free
channels, for serving a foreign trade agreements (FTAs);
market, 119 shortcomings of, 210; Vinerian
Organisation for Economic analysis of, 209
Cooperation and Development producer-driven chains, 12
(OECD), 9, 29, 172, 240 production process, 305
organised retail market in India, product life cycle, 118
share of different segments in, 50 Proximity-Concentration
outsourcing of business services: Hypothesis, 119–20
emergence of, 260 pseudo-landlocked region, 288
 378 •Index

see also Transhipment, India- for, 74–77; and global retail

Bangladesh relation and issue regulations, 55–57; literature
of route for Northeastern review and existing views on
Region FDI, 57–60; long-term and
public–private partnership, 75, short-term job prospects in,
212 67; manufacturers, 69–70;
purchasing power parity (PPP), 47 overview of, 48–50; policy for,
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51–55; regulation of, 55–57,

RCA indices: for India, US and 76; retailers’ survey, 62–64;
Singapore, 220 retail outlets, employees of,
real exchange rate (REER), 122 64–69; share of different
real growth rates, 189 segments in, 49; single-brand
recessions, 203; in US and Japan, policy of 2006, 73; single-brand
193 retail policy, 54; supply chain
regional arrangements, 210 agents, 60, 70; survey design
regional interdependence: and research methodology for,
determinant of, 191–92 60–62; survey findings, 62–74
regional trade agreements (RTAs), retail trading, 52; zoning
31, 210 restrictions on retailers, 55–56
regional value chains: on SME revealed comparative advantages
products, 337 (RCAs), 211, 262; of
Relative Degree of Trade Intensity Bangladesh LEPs against South
(RDTI): between India and Asian countries, 361–62;
other trading partners, 223; country comparisons in
meaning of, 222 comparative advantages in
Reliance Retail Limited, 50 business services based on:
remote sensing, 83, 85, 89–90 (industry competitiveness
Reserve Bank of India (RBI), 25, analysis in CIS through,
36, 115 270–73; measures of, 268–70);
Retailers Association of India services of India and other
(RAI), 59 trade partners, 219–22
retail outlets: average salaries
and other benefits across, 65; Schwarz Bayesian criterion (SBC),
consumers’ ranking of various 157
parameters in, 72; distribution Schwarz Information Criterion
of respondents who have tried (SC), 104, 131
working in, 68; employees of, second regionalism see New
64–69; trainings and outlets regionalism
imparting training, 66 Secretariat of Industrial Assistance
retail sector, in India: associations (SIA), 93, 115
and export councils, 70; service sector, in India:
barriers faced by unorganised categories of exports,
and organised retailers, 63; 214–15; contribution of,
consumers, 71–74; FDI policy 213; deregulation impact on,
 Index •3 7 9

228–29; liberalisation impact stock prices: expectational nature

on, 214 of movements, 194; in US
service trade, bilateral: between through 2007, 186
India and other countries, Straits Times Market Index, 196;
216–19 Shanghai Indices on, 200;
service trade, in India: barriers to, standardised coefficients from
226–29 daily, 198
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Shops and Establishment Act, 51 Structural Adjustment Programme

short-term loans, 1 (SAP), 143–44
simultaneous-equation model, for student enrolment, international:
analysis of economic policy, 35 in India, 244
Singapore: RCA indices for, 220 student mobility: of international
single-brand retailing, 52 students, 237; (in India,
site-specific crop management empirical study, 245–55; at
(SSCM), 88 tertiary level, 242); push and
small- and medium-scale pull factors, for worldwide
enterprises (SMEs), 52, 64, pattern of, 236–37
336–38 students studying abroad, from
SMART model, 210 see also India- India: destinations and number
Japan FTA of, 245
socio-economic classification supermarkets, 59
(SEC), 61 supply chain agents, 60, 70–74
South Asian Preferential Trade sustainable development,
Arrangement (SAPTA), 290 84–85
Special Economic Zones (SEZs)
Policy, 2000, 317 Taylor’s series planar
‘splinter off’ services, 260 approximations, for analysis of
Standard & Poors’ (S&P), 197; vs. economic policy, 34
three Asian stock indices, 187 telecom: TRI of India for, 228
state agricultural universities Tesco, 53
(SAUs), 89 TodaYamomoto Test: based on Sur
State List, 51 estimation, 157; data sources,
Statistical Yearbook, 246 period of study and variables,
stochastic frontier method (SFM), 150–51; empirical results, 156–
172–73 58; recent empirical literature,
stochastic production frontier: review of, 147–50; research
for domestic firms, 178–79; techniques, 151–56; theoretical
with inefficiency coefficients literature, review of, 145–47;
HHI and HHI spillover, 180; and unit root tests, 153–56; as
with inefficiency coefficients a version of granger causality,
RD and RD spillover, 181–82; 151–53
maximum likelihood estimates trade in business services,
of, 176; tests of hypothesis of, competitiveness in: collective
177 ability, of firms, 263–64;
 380 •Index

competitive outcomes through foreign students enrolment in,

relative market share analysis, 241; market capitalisation, 194;
273–76; parameters of, 262; RCA indices for, 220; recession
trade in total services, 264 in early 1990s, 193; re-coupling,
trade in services: definition of, of emerging markets in 2008,
2; economic characteristic of, 192; service exports and
7–12; to GDP (percentage), imports, to India, 217–18;
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9–10; world exports of world’s consumer, role of, 187

commercial services, 9 United States Department of
Trade Related Aspects of Agriculture (USDA), 87, 103
Intellectual Property Rights United States–India Trade Policy
(TRIPS), 31 Forum (2005), 211
Trade Related Investment unit root tests, 103–4, 129–30,
Measures (TRIMs), 31, 77 153–56
trade restrictiveness index (TRI), UN Services Database (UNSD),
227–28 263
trade similarity index: between urban planning, 56, 75
and other partners, 225–26 Urban Transport Strategy, of World
transhipment: India–Bangladesh Bank, 284
relation and issue of route for Uruguay round, WTO, 7
Northeastern Region, 288–95; US housing prices: during financial
meaning of, 287 crisis, 186
transit charges, 286
transnational corporations (TNCs), value chain and productive
113 network, 12–13
TRIPS Plus, 31 variable rate technology (VRT),
Tripura government: demand 83, 88
for transit route through vector autoregression (VAR)
Bangladesh, 282 model, 149; for analysis of
two-dimensional fragmentation economic growth, 104–5, 123–
theory, 306–7 29, 131; lag order selection
criteria, 132
UNCTAD Handbook of Statistics Vector Error Correction Model
2009, 103 (VECM), 149
Union List, 51 vector moving average (VMA), 127
United Nations Conference on
Trade and Development Walmart, 51, 53
(UNCTAD), 113–14 Water Use Efficiency (WUE), 88
United Nations Educational, wholesale trade, 64, 76
Scientific and Cultural Working Group of India–US
Organisation, 246 Knowledge Initiative on
United States: decrease in demand, Agriculture, 89
187; economic weight, in world market share (WMS), 262,
international economy, 189–91; 273–78
 Index •3 8 1

World Trade Organisation (WTO), levels, on domestic industry by

2, 28, 47, 189, 209, 213, India, 317; Schedule of Specific
237–38, 263, 287–88, 317, Commitments, 56; Trade
325, 330; agricultural trade Related Investment Measures
and removal of quantitative (TRIMs), 77
restrictions, 84; Doha world trade system, 84
Meeting (2001), 31; India
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commitments, in Uruguay Zero Duty EPCG Scheme, 318, 331

Round, 226; India–US trade, in zoning restrictions on retailers,
services, 211; lower protection 55–56, 59