Direct Investment in India – Dissertation Sample

What has been the economical impact of foreign direct investment in India

Mainstream literature on FDI argues that it has impressive and positive impact on the host country’s economy. The prevalent view is that FDI generates wealth, productivity and improves the skills of the local workforce. Another widely cited positive impact of FDI is its provision of access to new technology, particularly through imports of capital goods

According to globalization theory in a postmodern world, time and space become more closely connected. Globalization may be defined as the formation of  dense connections between people and places, in terms of trade, mobility and the exchange of ideas and technology; what David Harvey has called the “time/space compression” (Harvey cited in Kalb and Pansters and Siebers (eds), 2004,  p.11). This has coincided with the “Third Wave”, the period after the industrial revolution and the emergence of the information technology economy, which is dominated by industries that produce, manipulate and transmit information.

Political scientists have also been referring the obsolescence of the state, while the construct of the nation-state has been discredited. A nation- state can be defined as a state where the population is homogenous and consists of only one nation. With the exception of perhaps Japan and Iceland, this is a rare phenomenon, as most states tend to have more than one nation in their borders. The nation-state has therefore been presented by some as a mere myth that has been used to feed state dominance.

This study will apply globalization theory to analyzing the impact of FDI on India’s economy. The paper will analyze the impact of FDI in India on a regional/ spatial basis. Are FDI flows concentrated on certain regions of the country? Has FDI affected different regions in different ways? Has FDI increased spatial disparities?

Also, we will use the case study of Bombay to explore the “global city” hypothesis (Sassen 2002). If Bombay is a postmodern global city as some scholars have argued (Kamdar 1997), can we use it to predict the impact globalization will have on the rest of the country in the years to come?

1. FDI as part of Globalization Theory

In this chapter a general discussion on Globalization should be included. Globalization policies can be identified as:  marketization, privatization, liberalization and stabilization (Kalb in Kalb and Pansters and Siebers (eds) 2004). Neo- Liberal doctrine views globalization as good because: actors all over the world will prioritize the achievement of economic interest, thus middle classes will be formed and these middle classes will start demanding more civil rights, freedom and transparency. In this way, the outcome will be greater international trade, growth and prosperity for all. However, greater inequality might also come as a result of such policies. According to Kalb, where Washington Consensus- style policies have been adopted unrestrictedly, inequality has risen dramatically e.g. in Africa and South America (Kalb in Kalb and Pansters and Siebers (eds) 2004).

The hypermobility of capital e.g. FDI is another aspect of globalization. Theoretical aspect of FDI should be discussed.

2. Geography in Economics: regional v. national/ city v. country

Include literature on obsolescence of nation- state. How international neo-liberalism and free market ideology has eroded state sovereignty. Sassen’s theory on “global cites” and the new geography of economics (Sassen 2002), as well as John Friedman’s “world city hypothesis” (Friedman, 1986).

Place volatility is another aspect of globalization, and “new places” in the world economy include: offshore banking zones, export processing zones and world cities (Sassen 2002). Export processing zones are areas mostly in less developed countries, where firms can set up production facilities for semi- finished goods and be exempted from paying tariffs on value added when reimported in country of origin. Offshore banking centers are banking centers that escape many of the national and international regulations governing bank transactions (includes tax shelters). A detailed analysis of global cities will be provided in subsequent sections (Sassen 2002).

Include theory on economic spatial variations within countries. Give examples of other countries with this phenomenon. Discuss the relevance of the Gini Index to this discussion (the Gini Coefficient and Gini Index have been devised to measure either income inequality or inequalities in consumption between individuals, households or groups).

3. Background of Regional Variations in India

Include historical background on regional variations within India. Cultural differences between regions should be included. History of each region in terms of development; levels of infrastructure in each region; education levels in each region; concentration of industries in each region; level of urbanization in each region. Include data on FDI flows to specific regions within India. The subsections should be as follows:

a. Maharashtra
b. Andhra Pradesh
c.  Karnataka
d. Tamil Nadu 
e.  Gujarat
f. Bombay

4. Assessment of FDI impact with regional differentiation

Include findings from statistical and other empirical sources. Use 6 subsections for individual findings in each state, and in Bombay which will act as a case study for the “global city” hypothesis. The sections will be as follows:

a. Maharashtra
b. Andhra Pradesh
c.  Karnataka
d. Tamil Nadu 
e.  Gujarat
f. Bombay
-social polarization
-cosmopolitanism v. provincialism
-rise in real estate prices

Literature Review

Relative to our project rational is the article by Friedman, and its proposition of a world city hypothesis. The hypothesis has five main components: first, the structure of a city is determined by its function in the world economy, second, cities are “basing points” in the world economy and there exists a global urban hierarchy, third, cities are main sites for the concentration and control of global capital, fourth, world cities are main destinations for international migration, and fifth, world cities are characterized by a high degree of social polarization (Friedman 1986).

According to Sassen, cities are the replacing countries as units of analyzing the world economy. Sassen explains that the study of economic internationalization based on a city- unit analysis, should include the following components: breaking-up nation-states into different components that might be significant to understanding international economic activity, removing focus from the power of large corporations over governments to activities necessary for maintaining a global network of factories, service operations and markets, and focusing on place (the geography of strategic places on a global scale) (Sassen 2002).

Sassen argues that recent changes in the world economy and the shift to Services and Finance has renewed the importance of cities as sites for certain activities and functions. There have emerged “global cities”, but at the same time peripheral territories that are excluded from economic growth. Sassen points out to the links between major international financial and business centers: New York, London, Tokyo, Paris, Frankfurt, Zurich, Amsterdam, Sydney and Hong Kong. This network now includes cities such as Bombay, Sao Paolo, Mexico City and Buenos Aires (Sassen 2002)

Global cities are strategic sites in the global economy because of their concentration of command functions and high level producer service firms oriented to world markets. Global cities have a high level of internationalization in their economy and social structure. These cities do not simply compete with each other, but relate to each other in distinct systemic ways e.g. the interaction between Tokyo, New York and London in terms of finance and investment resembles a “chain of production” in finance (Sassen 2002).

In his detailed scrutiny of the direct and indirect impact of foreign direct investment on productivity growth in Indian manufacturing, Rashmi Banga ( Banga 2002) modifies such views, arguing that the impact of FDI depends on a number of factors and distinguishes between direct and indirect impact. Banga’s study provides a focus on the impact of market demand conditions in the Indian economy during the period of analysis (1987-88 and 1989-90 to 1994-95) and distinguishes between different sources of FDI using Japan and the USA as case studies.

Conventional wisdom on the technology spillover effects of FDI argues that where the technology gap is small, there is a substantial spillover, but where the gap is big, there is not ( see Tsou and Liu 1998). Applying this to the Indian economy, Kathuria argues that positive spillovers are indeed possible, but this depends on many factors such as the industry involved and on the R & D capabilities of firms (Kathuria 2001). However, as Banga points out, these studies have not taken into account the impact of market demand conditions or the source of FDI.

Banga’s study supports three main hypotheses. The first is that “FDI is expected to have a negative impact on total factor productivity growth of the industries if there exists a low market demand conditions” (Banga 2002, p.8). This is a simple proposition; if there’s low market demand then foreign firms might act as predators, cutting down the market share of local firms. Therefore, in this instance, the indirect impact of FDI is negative (Banga 2002).

The second hypothesis is that “Japanese FDI are expected to have larger positive spillover effects on total factor productivity growth of domestic firms as compared to US FDI” (Banga 2002, p.9). This is accounted to the “uniqueness” of Japanese corporations, the Japanese mode of technology transfer, corporate financial structures and the nature of Japanese and US FDI aims; short- term profit is a priority for US firms, in contrast to the Japanese: “Japanese firms do not follow aggressive output strategies that aim at short- term profitability and so may not engage in price wars. They are therefore less likely, as compared to the US firms, to cut into the market shares of the local firms at a time of low market demand conditions” (Banga 2002, p.10).

The final hypothesis relates to the “catch up” theory relating to the technology gap between the Multinational Corporation’s (MNC) home country and the host country, which argues that the latter’s contact with the MNC’s technology or innovation which result in a spillover, whereby the host country will catch up and come close to the level of the MNC. The hypothesis is as follows: “the initial productivity gap between domestic firms and Japanese firms will be positively related to the TFPG of domestic firms and therefore support the ‘catch- up” theory, however the initial productivity gap between domestic firms and US firms may not be positively associated” (Banga 2002, p.11). In other words, “catch- up” theory holds for Indian firms in relation to Japanese firms, but not to US firms (Banga 2002).

Another valuable contribution of Banga’s study is his distinction between the direct and the indirect impact of FDI. Direct FDI effects include: increase in productivity growth, improvement in average skill and efficiency levels, increase in absolute productivity- enhancing expenditures e.g. through bringing in better technology. These are positive in nature. Indirect effects, however, may be negative. Banga seems to put emphasis on the timing of MNC entry; if FDI is introduced at a time when a market is expanding, then outcomes are positive, if the market is not expanding, outcomes might be negative. For example, if a foreign firm enters, breaking the monopoly of a local firm at a time of slow market growth, then the local firm’s productivity might be compromised (Banga 2002).

Chakraborty and Basu (Chakraborty and Basu 2002) employ co integration theory to assess the hypothesis that potential determinants of FDI inflows to the recipient countries include differentials in rewards of factor services, cost structures and market sizes. This study gives emphasis to the two-way link between FDI and growth. When analyzing the effect of FDI on growth, one should take note of FDI- related technological spillover that promotes growth.

The co integration approach integrates both long- run and short- run effects of the “two- way” relationship between FDI and growth. Short run effects include knowledge spillover brought about by an open, “outward” policy on the part of the host county’s government in combination with low labour costs. The long- run effects include potential and steady growth brought about by this knowledge spillover (Chakraborty and Basu 2002). Cointgration theory is therefore based on the view that “although economic time series exhibit nonstationary behaviour, an appropriate linear combination between trending variables could remove the common trend component. The resulting linear combination of the time series variables will thus be stationary, which means he relevant time series variables are coin grated” (Chakraborty and Basu 2002, p.1063).

Applied to India, the article explores the effects of the relationship between FDI and GDP by asking the following questions: did the liberalization policy of the government influenced significantly FDI flows in the country? What comes first for India: FDI or growth? How does FDI impact the share of labour in the total factor cost? The article employs unit root tests, weak exogeneity tests, model selection tests and co-integration rank tests.

According to Aggarwal, however, India has failed to effectively integrate with the global economy, resulting in a lack of large-scale “efficiency –seeking” FDI, particularly in high-tech sectors (Aggarwal 2002). The article explores two hypotheses: first that in a liberalized regime, Multinational companies perform better than local companies in export markets and second, MNC affiliates have more competitive advantage in high-tech than in low- and medium-tech industries. Aggarwal identifies two implications for India: “it appears that the economy is not fully integrated with the global economy and that existing industrial and technological capabilities need reorientation to attract efficiency seeking FDI; two, India’s competitive advantages still lie in low-tech sectors.” (Aggarwal 2002, p.132).

According to McCuloch, FDI and firm expansion comes as a spillover outcome of economic success: “both trade and foreign direct investment are simply aspects of competition among large firms” (McCulloch in Froot Ed., 1993, p.39). McCulloch argues that trade theory is good at explaining why  country shares of world production are in the state that they are, but less good at explaining company shares/ why production is controlled by foreign companies.

In his book India: Emerging Power, Cohen identifies the paradox of a country that is both “great” but also lacking proper sanitation. Cohen identifies two conflicting views on the literature on India. The first is that India is already a great power and with time the rest of the world will come to this realization. The second view is that India’s social weaknesses (centered on the caste system) and its lack of development means that India is far behind in becoming a great power (Cohen, 2001). This is characteristic of the literature on India, which is often contradictory. Could this be because of regional/ spatial disparities within the country? Would an analysis that takes this spatial aspect into account be more appropriate? Our case study gives a positive answer to these questions.


According to a recent survey on the experience of foreign direct investors in India, the top five states for investing are: Maharashtra, Andhra Pradesh, Karnataka, Tamil Nadu and Gujarat; compared to a similar study taken one year earlier, the top five states have remained the same (FICCI, 2004). This supports our hypothesis.

For the purposes of this study, data must be collected to identify which states/ areas in India have attracted the most FDI. The reasons why these areas have attracted more FDI must be explored; is it because of better infrastructure/urbanization? Then the regional impact of the FDI must be explored. Are there any obvious differentiations between these regions and other regions in terms of growth, skill, development? Also, what are the lessons for policy makers? What is it about the regions that attract more FDI which sets them apart? Should other regions try to imitate them?

To ascertain Sassen’s “global city” hypothesis, the case study of Bombay will be used. Does Bombay display any of the characteristics of a world city? What is Bombay’s position in the hierarchy of world cities? Is there any discernible impact of FDI in Bombay? How is this impact felt and by whom (consider that social polarization is a characteristic of world cities according to Friedman). Does the growth and technology spillover mentioned in the literature translate to development or better living conditions?

Our structure will be to measure the impact of FDI e.g. growth, development and so on, our actual entities are the regional FDI flows and empirical aspects of the study might include the impact of FDI on the lives of people in different regions, e.g. are there any improvements in living conditions in certain regions?

Finally, how does the case of India, and its regional variations, fit into Globalization theory? Has globalization broken the space barriers?


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