Saturday, December 03, 2011

India: Foreign Direct Investment In Retail

A political storm was unleashed in India when the government announced its decision to allow foreign direct investment (FDI) in the retail sector in India (the decision has been put on indefinite hold). This decision would allow Walmart and its equivalents to enter the Indian market.

What struck me is the very poor quality of the debate. Putting aside the ideology of "free markets", it was not clear at all what the problems are, and how FDI will help solve them.  A fact-based presentation of what problems may be solved (and what new problems may be created - I'll provide an example) will be useful in deciding what the right policy is.

The first question that occurred to me was - why hasn't the Indian corporate sector replicated Walmart on its own? Is it a lack of know-how? Is it a lack of capital? If so, yes, FDI can help with both. If there were other structural issues (e.g., poor transport infrastructure, intermittent electricity), I don't see how FDI in retail solves that problem.  So: what are the impediments to large-scale corporate retailing and how does FDI solve them?

Regarding capital, the global pool of capital is no doubt deeper and cheaper than the India-only pool. But supposedly there is a lot of money to be made in increased efficiencies in the Indian supply chains. So why is capital a problem? The ideology of the free market says that Homo economicus will find and exploit such opportunities.  I suspect that perhaps the real money is to be made only after market power has been accumulated, and to accumulate such power requires tolerating many years of losses while driving most the competition out of business, and so the need for deep foreign pockets. Concentration of market power cannot be good. The usual response is that Walmart has competition in the US, and so market power concentration is a false fear. But actually, Walmart has no effective competition in its market segment, AFAIK. Successful retailers try to be upscale of Walmart. So I have a open question there: does the claimed supply chain efficiency arise from simply from concentrated market power?

FDI advocates make an argument about the losses that occur in India's agricultural supply chain, that FDI will help fix that. Perhaps, but then I don't understand why the whole retail sector needs FDI, it is the food sector that does.  Why are we talking about FDI in all of retail, if the agricultural sector is where the problem is?

Let us focus just on the food sector then.   The FAO commissioned a study on world-wide food loss (losses from the farm upto the retail store) and food waste (losses at retail and consumer).  The 2011 report is available as a PDF file. From the report, it is clear that the South and Southeast Asia region has a problem with post-harvest, processing and distribution - in various categories such as grains, oil seeds, fresh produce, etc., the percentage losses are larger than in other regions such as Europe or North America.

Note that overall, the food losses per person per year are smaller in South and South East Asia than in Europe or North America. The numbers from this report are also cited on Wiki. For instance, food loss+waste in Europe per capita per annum is 280 kg (loss=190kg, waste=90kg) while in South and South East Asia it is 125 kg (loss=110kg, waste=15kg). But clearly there are efficiencies to be had. (A statistic that would have been truly useful is the waste&loss normalized to production to provide an absolute measure of efficiency. )

Chapter 4 of the FAO report deals with solutions to the problems of food waste and loss. A useful exercise for FDI advocates (and those opposed to it) would be to go over those solutions and point out where FDI would help, and where really other reforms are necessary.

Lastly, let me illustrate that the corporate supply chain may simply move food loss into food waste, and so not really improve matters. The FAO report, mentions, for instance,
Large quantities on display and a wide range of products/ brands in supply lead to food waste in industrialized countries. Retail stores need to order a variety of food types and brands from the same manufacturer to get beneficial prices. Consumers also expect a wide range of products to be available in stores. A wide range of products does, however, increase the likelihood of some of them reaching their “sell-by” date before being sold, and thereby wasted. When shopping, consumers expect store shelves to be well filled. Although certainly beneficial for sales statistics, continually replenished supplies mean that food products close to expiry are often ignored by consumers. This is particularly difficult for small retail stores.
This, to me, is an example where the manufacturer has achieved efficiencies of scale, but the retailer necessarily has wastage; and I don't see how India avoids it if it follows the OECD model.
There is also an article in the Hindu newspaper, about the experience of retailers in China.  Even with FDI, Chinese firms dominate, but the article points out that Chinese barriers to foreign firms are different from those in India.   Also, there is anecdotal evidence in the article that farmers do not get higher prices (contrary to the claims of Indian FDI advocates), that farmers are driven off the land and that small retailers are driven out of business  - which may not matter in China where industrial employment is increasing rapidly, but will matter in India unless there is employment growth in other sectors.

All of these things need to be weighed and if the government has indeed looked into all of this, it needs to publish its findings - in order to know whether the proposed FDI policy is good, or merely driven by ideology, politics and the need to be seem to be doing something.

PS: I recognize that changes in the retail sector may be
a. necessary, and/or
b. inevitable.

These changes affect the economically most vulnerable people in India.  Isn't it the government's job to ease them through this transition rather than introducing change as a shock?