Sunday, November 27, 2011

De-globalization and Re-localization: Towards One Economic World

The growth of all developed countries had been in a large measure due to such countries driving their industrial and economic growth based on not only strong internal consumption but also aggressive overseas exports. The exports from developed countries typically comprised technologies, capital goods, raw materials, components and finished goods to other countries. In recent years, the developed economies have started to support their faltering economies by outsourcing their production to low cost emerging economies while the emerging economies started adopting the developed countries' model of export led growth. In the meanwhile, the global financial volatility of the last several years continues unabated. In fact, it is spiked up by the growing public debt of several developed countries and collapse of domestic demand-supply bases in such countries coupled with unpredictability of exchange rate regimes. This has, in turn, cast a serious shadow on the relevance of export led growth models that are sought to be pursued by the emerging economies.

There are, of course, significant differences in the characteristics of the developed and developing economies. The developed countries are characterized by flagging demand and low job creation, especially in the manufacturing sector, in a demographic shift towards the aged and an economic mix dominated by services. The developing countries are characterized by surging demand and high job creation, boosted by a demographic shift towards the young but constrained, however, by poor quality of infrastructure and huge urban-rural and rich-poor divides. The export led and foreign investment led models of growth of emerging markets are threatened by the economic uncertainties faced by the developed economies. This has depressed demand and increased the global financial volatility which has, in turn, affected investment flows. There, however, seems to be little appreciation by policy makers and industry leaders of the emerging markets on the risks to their growth models. The emerging markets seem to be chasing the overseas chimera while ignoring the domestic growth needs. There is a need for both developed and developed countries to re-prioritize the globalization and localization models.

Viability motive in developed countries

As the Eurozone crisis demonstrates, developed countries are committed to sustaining current living standards affected by lower incomes and lower savings with lower costs of products and services. Their emphasis is on searching globally for the least cost sources even while continuing the approaches to develop new products and new markets. While product development has no doubt accelerated in the last two decades in the developed economies the acceleration has not been a determinant of greater gross incomes. The impact of enhanced innovation is reduced by the shorter product life cycle. New products typically substitute the previous generation products rather than co-exist. With the consumption driven society facing incomes crisis, the strategic mindset of the developed markets is focused on sustaining viability through cost competitiveness rather than through value enhancement.

The strategic mindset of viability at any cost (actually at the lowest cost possible!) reduces the innovation levels due to reduced investments on research and asset modernization. At times, the unceasing quest for the lowest cost also impacts quality as demonstrated by the problems faced by certain product categories due to imports from certain countries. The financial orientation is compounded by an analyst and investor mindset which relentlessly focuses on quarterly results, especially corporate profitability and shareholder returns. This emphasis, no doubt, trains the managements to conserve resources and minimize waste but it also makes them risk, investment and innovation averse while driving them to globalize to outsource and reduce costs. It requires significant leadership strength to fight against the dominant trends and reinvest for growth. It is a moot point if the state of frozen growth faced by the developed countries needs to be thawed by government incentives, industry actions or firm level competitive moves. In all probability all are required in unison.

Growth motive in developing economies

The emerging markets, especially China and India, have been notching up high rates of economic growth for the last several years. In fact, it is said that the unrelenting infrastructure development and competitive manufacture have made China the most important partner for several developed economies. India has also been treading a similar path, albeit with a lag. However, global adversities and local inflation are slowing down growth in emerging economies. The impact has been two fold; reduced investments from developed countries serve to reduce new project formations in emerging markets while increased inflation in emerging economies affects the cost-competitiveness of products and services. There is, however, no predictable outcome of the changing equations given the unpredictable movement in exchange rates. As corporations in emerging markets are buffeted by these several adverse trends, export-led growth becomes a somewhat shaky model.

The emerging countries seek to bolster their competitive position in the changing scenario by opening up the economies even more. India, which has gained significantly from the opening up of the economy to foreign investments, has been facing some criticism for not opening up the economy even further to make India an even more favored destination for foreign investments. There is, however, equally a pushback from certain quarters based on concerns arising out of land use, import-led project creation, squeeze of small and micro enterprises, exploitation of indigent farmers, and so on. In the absence of an objective discussion, the subject of further economic reforms is tending to be more polemical than technical. Some examples such as the current foreign direct investment policy for pharmaceuticals, sale of Cairn oil business or new policy on foreign direct investments in multi-brand and single-brand retail are indicative of the controversies relating to quick policy fixes devised from time to time to keep the emerging economies growing at a fast clip.

Market-led or factor-led?

Emerging markets have to rethink their development and growth strategies. For India, in particular, although opening up of the economy brought in excellent benefits of outsourcing in the past, a similar strategy may not provide similar results in future, at least on the same scale. If the first phase of reforms brought to the fore the relevance of India’s factor inputs (technical and managerial talent; human and corporate side of free enterprise), the second phase could provide a much larger menu of options based on a switch to market based growth. This is because factor-led growth focuses on making global products cheaper using India’s low cost factor inputs and conversion economics. Many times this could be only for captive consumption through directed development. Depending on the standing of the sponsors, the factor suppliers or the conversion specialists would prosper. Even then, most production in the factor-led model enables viability to global developed markets rather than to the domestic markets.

Market-led growth on the other hand focuses on the huge domestic demand of the emerging economies that remains untapped. It would provide additional product scope and manufacturing scale to the base levels of the factor-led model. The domestic market would have additional products at appropriate value points, often developed through creative science and frugal engineering. The additional scale and scope thus obtained would also have collateral positive impact on the basic global products of the sponsor. The policy regime of India (whether of 100% EOUs or SEZs), however, provided incentives and tax breaks only to export production and sale. Any domestic sale by such companies would draw equalization of duties and taxes, hiking up the pricing of products for the domestic tariff area. In one sense, penalizing the domestic market with higher prices is inequitable, and deserves correction in the current phase of reforms.

De-globalization, re-localization

At the core of the new paradigm for balanced growth of the Indian economy must be a balanced emphasis on globalization and localization on a 50:50 ratio, as a general guidance. This means that every enterprise must seek to cater to global markets and local markets equally. The advantages of this mindset shift for the Indian enterprises and economy would be enormous. Those firms that are steeped in antiquated products and sheltered under low value points with 100% local market oriented production will start understanding and absorbing global technologies, in terms of products, processes and quality. Apart from achieving better revenue status through the newfound export orientation, such enterprises would also be integrating the new technologies for the local market, achieving better competitiveness in the local markets. The economy would obviously benefit through additional export revenues from the hitherto wholly domestic oriented units and the expansion of the local market with better products by such firms.

The 100% export oriented units would conversely dedicate 50% of their capacity for serving the local market. This would enable such firms access the vast and growing Indian market and achieve business stability, even if accompanied by a pricing compromise required for the domestic market. Such a move to allocate 50% of the capacity for the domestic market would benefit the enterprises in terms of a capability to develop and manufacturing products that suit the challenging Indian market. It would also enable the enterprises be better equipped to cater to other emerging markets. The economy would significantly benefit from the availability of global product range in the country without resort to costly imports. On an overall basis the 50-50 approach would also address the concerns of the developed world that outsourcing to emerging markets is all about low cost production; they would appreciate that the new approach secures market access too.

As a corollary to the 50:50 approach, emerging countries should also insist on at least 50% localization as a target, whatever be the product. This would enable the development of the industry even in high technology segments. For example, import of luxury cars on a completely built-up (CBU) basis would be modified to partial import and local assembly based on semi-knocked down unit (SKU) basis. While such approaches were there in the past, notably until the 1990s, they did not result in any significant gain as the demand did not exist for such high end products in India. The demand profile in the liberalized India is significantly different, and has its place for high end products. This would provide the requisite base for local component and manufacturing support for high end products too.

Policy regime, paradigm shift

The more balanced globalization-localization paradigm advocated herein offers multiple benefits as outlined. It brings economic development on to a more balanced platform globally, and provides stability to all economies. The emerging markets, however, need to put in place certain policy prescriptions to usher in this change on a sustainable basis. For example, the 100% EOU and SEZ policies may have to be modified to provide for allocation of 50% of capacity for the domestic markets as a target. Correspondingly, such production should not also be levied additional duties in the event of sale to domestic tariff areas. In order to ensure greater transparency and stability, a new 50-50 export-local policy regime should be brought in. The policy would help the Indian industry far more than individual sector reforms could help. There is also no need to be concerned that 100% EOUs and SEZs would have greater tariff advantage as a level playing field would be created for the hitherto wholly domestic units too.

Along with the intellectual property protection regime that is now in place in India, the new 50-50 policy regime should induce innovator firms in all industries to locate the production of their patented products also in India. This would enable the Indian public have access to patented products, especially in the healthcare sector and obviate the need for measures such as compulsory licensing. The innovator firms as well as the global consumers would have the benefit of lower cost development and production of generic as well as innovator products in India. While at first look the suggested 50-50 policy prescription may look threatening both to overseas firms and domestic enterprises, the principles of equality, technology and market access and level playing field that support the new policy prescription would provide tangible and sustainable benefits.

One economic world

Eventually, economic development would seek a global equilibrium. The developed world has seen limits to growth and profligacy. The emerging world which is tasting the first fruits of liberalization and prosperity would soon discover its limits to growth due to gradual erosion of competitive advantage. An ability to cater to domestic as well as overseas markets equally, and a capability to contribute at least 50% of local value addition would enable the Indian enterprise stay stable and competitive. The approach would enable the foreign enterprises be equal corporate citizens in the local markets providing global products competitively to local markets while benefiting from the talent and cost arbitrage that India offers. The de-globalization cum re-localization paradigm would lead to an equitable One Economic World, providing a rightful competitive position to emerging countries such as India.

Posted by Dr CB Rao on September 27, 2011

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