Indias Automotive Industry And Investment Environment

Published Date: 02 Nov 2017

In order to fully understand the importance of the Indian automotive industry, one most look at a brief summary of the presence global automotive industry and understand how the industry exists in today’s day and age before moving on to consider the role India’s automotive industry plays in the world as well as the attractiveness of its investment environment. This is described below.

Introduction

"If the mantra in real estate is ‘location, location, location,’ the mantra for businesses in the automotive industry should be ‘diversify, diversify, diversify’ if they want to survive in the tougher post-recession market" (Scianna 2010). Just as this mantra mentions, it gives a small idea of how competitive the world of the automotive industry is. But as it is competitive, it is indeed essential. It is an industry which is directly linked to production of vehicles, which requires a horde of raw materials; it requires fuels and roads to run it. Despite the automotive industry being a part of problems such as road congestion and other environmental difficulties, it also offers almost an unending wave of social, political and economic inter-connections proving that its presence in the world today is of great importance. (Maxton and Wormald 2004)

Therefore, it is important to acknowledge the presence of the automotive industry and its significance in various parts of the world.

India’s automotive industry and Investment environment

As mentioned previously, diversification is vital to survival of the global automotive industry. India’s automotive industry is seen as having massive growth potential in terms of production hubs as well as strong emerging domestic markets. The fact that India is a trillion dollar economy with over a billion in population, over seventy percent of which are thirty-five or below, gives the green light to some automotive parts manufacturers abroad to come and invest as they predict unprecedented growth. Also, the market is seen as being profitable enough to take the risk for foreign companies to go there since 6 years ago in 2006, it was estimated to produce over a million vehicle units per year. Furthermore, India’s Gross Domestic Product (GDP), along with China and U.SA, accounted for over half of the world growth, according to IMF’s purchasing power estimates. (Rathore and Tilak 2006)

When considering foreign interest and investment, stakeholders from every part of the global automotive industry are expanding their presence in India. Also, the automotive industry in India is looking for suppliers to look for joint venture (JV) opportunities as well as technological partnerships. Also, India is comparing themselves to China by promoting their advantages over China to foreign investors which include how the one common language spoken in India is English, also the political and legal framework is more conducive for investors doing business. (Abdul 2007)

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Indian Automotive Industry

The present state of the Indian Automotive Industry

The Indian automotive industry consists of both the automobile sector as well as the components industry. These have grown over the years, and are now present in the form of clusters in different areas all over India, mainly Bombay, Delhi and Chennai. The industry due to its unending wave of social, political and economic conditions as mentioned before is the main reason why the Indian automotive industry has formed clusters all over India. (Ministry of Heavy Industries and Public Enterprises 2006a) These clusters are basically concentration of the automobile or automotive components industries, some of which are now adhering to international standards by placing their suppliers nearby the Original Equipment Manufacturers’ (OEMs) production locations. The aftermath effects of adhering to this standard are that with the supplier base close-by, vehicles are able to be produced more efficiently and effectively. (Singh 2004)

Source: ACMA (2011)

Segmentation

When considering how to segment the Indian Automotive Industry, different factors such as the vehicle type, size or weight helped SIAM (2007) categorize the automobile sector into four segments: Commercial Vehicles which covers five percent of the entire market share of the industry, Passenger Vehicles which cover fourteen percent of the industry, Two-wheelers which covers seventy-seven percent of the industry and finally three-wheelers which covers four percent of the industry.

Another new segment that has entered into the market rather unsuccessfully at first due to the infrastructure unable to support it, but looks to pick up very soon and being introduced by the government to invite many companies and encourage FDI inflow is green motoring. (Shanmugan and Mohamed 2011) Other forms of segments in the industry are being currently made, are luxury car segments, cars specifically designed towards youth and women. (KPMG 2010)

Challenges and Strategies

In India, a massive population invited FDI because investors see a huge market ready to exploit with different vehicles in different segments. However, much of the local Indian population has been living below the poverty line and are unable to afford vehicles. This poses a challenge to foreign and domestic firms alike to make sales. Furthermore, poor condition of the road network hinders progress and poses a challenge of its own as to what forms of vehicles are likely to be purchased in different areas. Strategies such as incentives for firms such by setting up exclusive dealerships would cost much more in large cities, so management of distribution is a critical strategy to define success. (Bhaktavatsala 1992)

However, strategies to counter these problems have risen in the form of recent middle-class population now having more disposable income to spend. Urban middle-class populations are being targeted by firms in the industry, as well as the poor populations who also have more disposable income is moving towards the two-wheeler segments. Recently, commercial and passenger car segments had grown and this has been attributed to incentives such as subsidies on diesel prices. (India Autos report 2012) A reason for targeting the Indian masses is that cars are shown to enhance social status, and there is argued to be a strong association of price paid and status, therefore luxury car segments are also another vastly growing segment in the industry now, targeted by companies such as Mitsubishi, Daimler and BMW who aim to reduce costs by making a much larger manufacturing segment. (Just-auto 2012)

Another challenge that has been present is the import of automobiles in the Indian market in completely-built-in units (CBUs), often attract high custom-duties in India. Despite reducing these duties on a constant basis, the duties are still high enough to discourage a large portion of the market or importing CBUs. For example, during the period of 2005-2006, total value of imported CBUs was 102 million USD over the production price. The strategy to counter this however was several foreign automobile manufacturers setting up production facilities in the country. This led to increased competition with the domestic firms, and the competition forced domestic firms as well to create world class technology products that have stimulated demand. (Ranawat 2009)

New strategies by domestic firms in taking advantages of undertapped segments such the luxury car segment, the youth segment, the women segment and the more recent one which is green motoring that the government is so vehemently supporting, can see such firms becoming the new major competitors of tomorrow and can also see the exit of many competitors depending on how well firms in the industry prepare themselves for the new segments to optimally profit from the market. (Shanmugan and Mohamed 2011) (KPMG 2010)

Key Competitors

There are a number of major competitors in the Indian Automotive Industry both in the domestic sector and component manufacturing areas.

Maruti-Suzuki, the market leader in the domestic industry is expected to fall in sales as it faces major competition from global competitors such as Volkswagen, Hyundai, Ford and Toyota. Toyota has been developing a new model known as Etios for a long period of time just to target Indian market. Mercedez-benz, Daimler and BMW are expected to launch a much larger manufacturing segment in India to decrease costs, and showing further growth in the luxury car segments in India. (Just Auto 2012)

Even Sweden’s Volvo Buses subsidiary in India has already announced plans to invest US$81 million over a five-year period to expand its capacity, develop new products with intent to build on India’s booming commercial vehicle segment. (India Autos report 2012)

Maruti’s competition by bringing out cars such as the Kizashi, to compete with Toyota Camry’s, Honda Accord’s, and Volkswagen, as well introducing new variants of best-sellers at cheaper prices than existing models (Alto, WagonR) in order to defend market leadership has helped keep the market competitive and prices down. Toyota’s new Etios model ensures this while targeting urban middle-class population, and still targeting doubling its car sales over the years. (Just Auto 2012)

Domestic Competitors

Source: DIBD (2012)

International Competitors

Source: DIBD (2012)

Types of Entry Modes

The earlier part of this document has been focused on the Indian automotive industry, and the role of FDI in impacting it. However, FDI is not the only entry mode chosen by foreign investors. Globalization has been growing at a hasty pace in recent years, and this is reflected in the entry modes chosen by respective firms when deciding to expand their international presence into other countries and market their respective services (Hassan and Kaynak 1994). The choice of entry mode according to transaction costs theory requires an assessment of coordination costs related to the internalization as well as transaction costs resulting from the search of, negotiation with, and control of a market partner. (Puck et al 2009) The entry modes are discussed below.

Export

Exporting generally means the firm first obtains knowledge and experience from the host country via means of exporting, and then proceeds to grow operations into host country via ownership of production or distribution facilities. (Johanson and Vahlne 1997.) This entry mode allows internationalization of the firm without a large investment into the host country’s market (Agarwal and Ramaswami 1992).

The incremental process of expansion via exporting happens in five stages. It first begins with export awareness which considers identifying problems or prospects, then moves on to export purpose whereby contributions of exports are examined, then on to trial which looks at personal experiences from limited exporting, then on to export evaluation whereby results from exporting are studied, and finally export acceptance where the firm eventually decides on whether to export or not in the host country. (Reid 1981) Studies shows that the intensity of the export depends on the relationships established by firms with foreign mediators or distributors. (Bonaccorsi 1992)

Licensing

This is whereby a firm (the licenser) provides intangible property i.e. patented data, trademarks, data and know-how that consists of specifications, written documents, computer programs, and so on, including data required to sell a product or service, with respect to a physical territory to a foreign party (another firm, the licensee) in exchange for a royalty fee. (Mottner and Johnson 2000)

The importance of licensing is that domestic firms paying royalties to purchase advanced technology from their parent companies, can increase their productivity effectively and efficiently and compete well in the market place. This is as domestic firms performing in-house research and development (R&D) are sometimes ousted by large MNC’s taking up market-share with advanced technologies, but if a firm is a subsidiary, they can license the technology and it is a low investment as well as low-risk alternative. However, it also means the licensing firm has the least control. (Agarwal and Ramaswami 1992)

Franchising

Franchising is a superior form of international licensing whereby the focal firm (the franchisor) allows an entrepreneur (the franchisee) the right to use an entire business system in exchange for compensation. (Cavusgil et al 2008). However it is a longer-term commitment. The franchisee is allowed to use the complete business package of the franchisor, which includes the training, support as well as corporate name therefore allowing the franchisee to operate their business using exactly the same standards as other subsidiaries in the franchised chain. (Quinn and Doherty 2000)

Entry Mode

Advantages

Disadvantages

Exporting

Ability to realize location and curve economics

High transport costs

Trade barriers

Problems with local marketing agents

Licensing

Low developmental costs and risks

Lack of control over technology

Inability to realize location and experience curve economics

Inability to engage in global strategic coordination

Franchising

Low developmental costs and risks

Lack of control over quality

Inability to engage in global strategic coordination

Wholly owned subsidiaries

Protection of technology

Ability to engage in global strategic coordination

Ability to realize location and experience curve economics

High costs and risks

Source: Hill (2011)

FDI

Firms have different motives when deciding to expand via FDI into other countries due to their distinctive competencies and constraints, which in turn affect their operations as well as performance. (Cui and Hon-Kwong 2001)

When considering how a firm decides to expand by means of FDI into other countries, and it consists of different modes of its own which include: joint-ventures, wholly-owned subsidiaries and strategic alliances. These are not one-time decisions, but rather decisions made in order one after the other. The decision of which entry mode to choose depends on cultural-distance (i.e. incomplete understanding of the host countries values and institutions to make appropriate social exchange), political conditions, market-specific uncertainties all affect a firm’s decision on which entry mode to pick when utilising FDI as an entry mode to enter a country. This is especially true in the case of emerging economies e.g. joint-venture reduces environmental risks whilst also ensuring certain commitments to domestic markets which are favoured by firms in their initial entries. (Zhang et al. 2007)

Wholly-owned subsidiaries

This is a form of entry used in instances whereby a firm possesses a hundred percent of the stock, and is established in a foreign market either by setting up a new operation in a host country, or obtaining an established firm, otherwise known as cross-border acquisition, in the host nation to promote its products. Hill (2011)

International Joint Ventures

This is either a separate or a new corporate entity whereby two or more legally diverse firms supply assets, own the entity to a certain degree (typically fifty percent each) and share associated business risks (Harrigan 1988).

Motives for FDI

Earlier the entry modes that foreign investors could choose to enter countries were explained. But these entry modes depend upon the specific motives of the investors. Motives for any firm to go abroad differ with the firm involved. However, the positives that the firm sees in going abroad can also work against them e.g. even though the firm stands to obtain large returns to scale in many of its operations, it works only in one market (in this case, the Indian market) to achieve those economies to scale (EoS). But, if the EoS are associated to production or transportation, it spurs the firm to work in more than one market to offset production, one way is by moving production or parts of it to a location that is of minimal cost. Also, MNC’s work best in imperfectly competitive markets, in summary this means firms move to areas where they can force down/control prices, making their motives: market-seeking, efficiency seeking and resource seeking. (Tayeb 2000)

Dunning’s (1980) eclectic theory of FDI uses his Ownership, Location and Internationalization (OLI) framework , which similarly describes a company’s motives as explained above, to derive one more motive, and that is strategic-asset seeking. (Dunning 1980)

Resource-seeking

This is dependent on availability of a certain resource or input in a certain market e.g. Majority of oil companies have invested in oil refineries in Middle East for this reason. (Tayeb 2000)

Infrastructure is an important resource seeking factor as superior infrastructure improves the productivity of investments, and thus draws more FDI (Wheeler and Mody 1992).

Dunning (1980) argues that imports are one of the resource seeking factors as well. The relationship will be positive for investing country if it requires certain resources not available in the host country, and are imported, then increase in production will increase imports of inputs thereby bringing a positive correlation between imports and FDI. (Algucil and Orts 2002)

Market-seeking

Size of the market is seen by a firm as an important factor before going there, as it promises larger profits. Therefore emerging markets with big populations such as China and India have been popular destinations for many firms. Considering India, most popular car has been Maruti Suzuki (Tayeb 2000). Nunnenkamp and Stracke (2008) showed a strong positive correlation between population and FDI

Gross Domestic Product (GDP) is also theorized to be another indicator of attracting FDI inflows as it seems logical that countries with rapid economic growth draw more FDI. Agarwal and Aman (2005) researched and came up with the conclusion that size of the host country market is the most popular motive for external investors to invest in the host country, particularly concerning FDI flows to developing countries.

2.4.3 Efficiency-seeking

Companies move to certain markets seeking to increase efficiency in their production or distribution e.g. Philip’s move of electronics and semi-conductors to Singapore and Malaysia (Tayeb 2000). This enables firms to be able to create a larger number of items at lower costs (either raw materials or labor resources, or both), and thus increase profit margins whereas if they were to set it up in their own markets, they would not be able to make such a high profit margin and may in some cases even go at a loss.

Inflation rate is an important efficiency seeking factor as high-inflation rate poses a red light to potential investors, stability is therefore required to attract foreign investors (Boltric and Skuflic 2005).

2.4.4 Strategic asset-seeking

This form of FDI motive is not only the quickest of all the motives explained, but it also aspires to advance a firm’s worldwide or regional strategy in a certain market into overseas networks of created assets such as machinery, organizational abilities and markets (Faeth 2009) . In other words, strategic-asset seeking is part of an MNC’s strategy to incorporate the relative pros of the chosen host countries business segment into their international networks. This form of FDI motive is therefore quite highly-sensitive to the availability of skilled labor, in the form of local employees with high quality of education, and hopefully international experience as well (OECD 2002)

Theories of FDI

This section discusses three profound theories in FDI, namely Dunning’s OLI paradigm, product life cycle and Uppsala model.

Dunning’s OLI paradigm

According to the eclectic paradigm theory from Dunning (1988), FDI takes place when three factors exist simultaneously, namely ownership (O), Internalization (I) and Location (L).

The first influencing factor, ownership advantage, stems from the concept of firm specific advantages. The ownership advantage can be seen as the prerequisite of the other two variables, and refers to the competitive advantages deriving from the operations of possessing and utilizing tangible or intangible assets privately or through common governance. In this dimension, with the assumption that other variables remain the same, the greater the ownership specific advantages relative to their competitors, the greater the propensity will be held by multinational corporations (MNCs) to engage in a direct investment to foreign country.

The second factor, location advantage concerns about the external environment of a MNC. The investment environment of a nation is one of the essential factors to attract FDI. MNEs that undertake with more abundance the immobile, natural endowments that can be used by the value adding business will in turn be more favourable so as to increase or exploit their FDI in the countries companies jointly with the company-owned competitive advantages, rather than other options.

The last factor, internalization, is mainly based on the transaction costs theory which suggests the competitive advantages can be achieved when the firm is able to internalize. This is because the large extent of internalization can help a MNC to reduce the holdup problems, minimise the transaction costs and therefore, enhance the competitive advantages internationally. According to Dunning (2000), the range of the methods can be varied from the trade of goods or services in an open market to the integration of intermediate product markets or buying of a foreign market. The greater the benefits of internationalization, the more the companies are willing to conduct the production by itself rather than through a resource transfer contract like franchise or technical service agreements.

Dunning (1988) highlights that the more the ownership, internationalisation and local advantages that the firms possess, the more the benefits the firm will be able to gain in FDI. The ownership advantages explain the reason why firms are in favor with going abroad. Location advantages discusses where should MNCs commit their investment. Internalization advantages address how the firm should operate, management and monitor the subsidiaries in foreign countries. More importantly, Dunning (1988) suggests that these variables interact with each other. FDI will only occur when all these factors exist simultaneously. Besides, as Dunning (2000) admits, due to the environmental factors, the importance of the three interdependent variables will change overtime, and also it will be various from firm to firm who actually response to the theory. As Dunning (1988) states out, different types of international production may require different kinds of explanations, thus it can not interpret clearly that, even in the form of FDI, why there are different selections between wholly owned retail chain and JVs.

Product life cycle

Raymond Vernon (1966) first proposed the product life cycle theory in his seminal article ‘International Investment and International Trade in the Product Cycle’. The author argues that organizations are highly stimulated by their local environment and are more likely to be keen on innovation when their immediate surroundings are more conductive to the creation of new techniques or products. In order to ensure a long-term commitment of internationalisation in the specific market, the innovations should transferred to other countries and these innovations are divided by the stages of product life cycle according to the developing forces of supply and demand for each specific product (Tayeb, 2000).

The rationale of this theory is that, the increasing process of cost reduction in the international context is the driver of the separation of innovation, production and so on. Moreover, MNCs who are able to minimise the relevant costs, can maintain and enhance their competitive advantages locally and internationally. Hill (2009) highlights that this particular model mentioned here of sequential decision making, has had a great influence on internationalization theory. In addition, it arises from the fact that the interaction of the evolving forces of demand patterns and production possibilities can dynamically influence MNCs’ internationalisation decisions (Vernon, 1966).

Utterback and Abernathy (1975) suggest that this model explains what happens to products and industries, and the relationship between FDI and trade. According to Vernon (1966), a product goes through mainly three stages: new product, maturing product and standardized product (see figure 1 and 2). In the first stage, an organisation develops, creates and introduces an innovative product. Since the product is new, the innovating firm is uncertain whether there is a profitable market for the new product. In this stage the product will be introduced in the domestic market. Williamson (1975) suggests that in this stage, the product should be located close to the target market in order to meet customer needs, satisfy target customers and improve the relevant product technologies.

The second stage is maturing product stage. The demand for the product expands dramatically as consumers’ awareness of the product value has increased to a large extent. The innovating firm builds new subsidiaries to expand the capabilities and competences and serve domestic and foreign demand for the product. In this case, domestic and foreign competitors begin to emerge, lured by the prospect of lucrative earnings.

The final stage is the maturity of the product that the product will become standardised. The product becomes more like a commodity, because the product have been imitated and/or produced by foreign and/or domestic firms, the companies are pressured to reduce their costs as much as possible by shifting production to facilities in countries with lower labor and raw material costs, or standardisation of product system. As a result, the product may start exporting back to the headquarters and other early producer countries (Griffin and Pustay, 2010).

Hill (2009) critically evaluates the model. Firstly, not all the products will experience all the stages of life cycle. Moreover, according to the author, the product life cycle ‘seems to be an accurate explanation of international trade patterns, however, it is not without weaknesses’. Since the study from Vernon (1966) spawned much of the empirical studies on international business, his statement that most new products are developed and introduced in the United States seems ‘ethnocentric’. Moreover, the accelerating process of globalisation and liberalisation, and integration of the world economy has induced the phenomenon that more and more new products become to be introduced simultaneously in developed nations. More importantly, as some of the nations have comparative advantages in some factor endowments that may more attractive to MNCs, some certain parts and components of the products are more likely to be produced in those countries. As a result, Tayeb (2000) argues that the product life cycle theory may able to explain the pattern of international trade and investment during the certain period of American global dominance. However, its relevance in the modern world seems more limited.

Figure: Innovating firm’s country

Source: Vernon (1966)

Uppsala model

The Uppsala model is firstly proposed by Johanson and Vahlne (1977). The authors examine the internationalisation process of MNCs by investigating the importance of knowledge development and the building of a commitment within the firm to foreign markets. The model posits that MNCs engage in internationalisation incrementally. Initially MNCs make only small investments in geographically and culturally proximate countries, but later, as more experience accrues, larger investments are made into countries distant on both counts. The model suggests that the FDI decision is the outcome of one decision or stage constitutes the input for the next (Tayeb, 2000).

The Uppsala model is based on the behavioural theory of organisation. The basic assumptions of the model are that lack of the knowledge about foreign markets and operations is an importance obstacle to the development of international operations and that the necessary knowledge can be acquired mainly through operations abroad. According to the model, when a firm has chosen a foreign market, the psychic distance to that specific market is assumed to be reduced due to increased market-specific knowledge. The psychic distance has been defined by Johanson and Wiedersheim-Paul (1975) as ‘…the sum of factors preventing the flow of information from and to the market. These include differences in language, education, business practices, culture and industrial development’. In addition, it is assumed by Johanson and Vahlne (1977) that MNCs strive to grow and to keep risk at a low level. The increase of the knowledge on the specific foreign markets is a means of reducing uncertainty and maintaining the commitment to the market.

Moreover, if knowledge of transactions can be transferred form one country to another, firms with an extensive international experience are likely to perceive the psychic distance to a new countries (Andersen, 1993), and the similarity is easier for firms to manage than dissimilarity, thereby firms are more likely to be succeed in similar markets (O’Grady and Lane, 1996).

Birkinshaw and Hood (1998) point out that the Uppsala model begins with assumption about the cognitive limitations and behavior of individual managers. Moreover, it explains ‘the internationalisation process in terms of the reciprocal relationship between: 1) levels of knowledge about, and existing commitment to, the foreign market and; 2) decisions regarding further commitment to the market which is affected by the firm’s perceived opportunities and risks’ (See figure 3).

Figure: The basic mechanism of internationalisation- state and change aspects

Source: Johanson and Vahlne (1977)

First factor, market commitment, is composed by two factors: the level of commitment and the amount of resources committed. The commitment can be viewed as locating resources in a particular foreign market or domestic market in order to commit to that market.

The second factor, market knowledge, is the essential of further commitment decisions. The market knowledge on the investment environment, opportunities, activities performance and results, competition and channels of forward and backward suppliers, and so on, can differ from market to market. Due to the market differences between host countries, the market specific knowledge is appreciable when it comes to further commitment decisions. Therefore, there is a direct relationship between market knowledge and market commitment (Tayeb, 2000).

The third factor is current business activities. Johanson and Vahlne (1992) highlight that current activities are important sources of market and firm experience. In order to serve the specific market, both market and firm experience are required since they are able to improve the efficiency, effectiveness and profitability of the business.

The final factor are commitment decisions, which depends on what alternatives are available and is based on perceived opportunities and/or risks on the market (Tayeb, 2000). In turn, the understanding of opportunities and risks are depending on the experience.

The limitations of the model have been pointed out by many scholars. O’Grady and Lane (1996) argue that ‘perceived similarity can cause decision makers to fail because they do not prepare for the differences’ and ‘the failure lies in the managerial decision-making aspect…to which international business researchers have not paid enough attention’ (Johanson and Vahlne, 1992). Moreover, Forsgren (2002) argues that although the Uppsala model seems to equate incremental behaviour with experiential learning, it is unclear that whether the incremental behaviour is the consequence of the learning or whether it is an independent event.

Impacts of FDI on India

India’s FDI policy framework

FDI has a long history when it comes to India’s approach towards dealing with foreign investments. India has been known to be careful when formulating FDI policies such that, FDI was welcomed in sectors of high technology and precedence in order to grow national capability while put off in low technological sectors to help domestic industries grow. In 1973, foreign equity in holding a joint venture was permitted by up to forty percent. Based upon other country successes in Asia, the government established special economic zones, also creating liberal policies and offered incentives to encourage FDI in the chosen zones to help promote exports. (Dunning and Narula 1996)

But, these policies did little to help due as India was still highly-protective. Noticing these drawbacks, Industrial policies (1980 and 1982) and Technological Policies were introduced, some of the industrial rules were de-licensed, Indian manufacturing exports were endorsed, imports of capital products and technology were liberalised to help modernise sectors. Furthermore, trade liberalisation measures were introduced through tariff reduction as well as transforming a large number of products from import licensing to Open General Licensing. All in all, this was to help India portray a liberal stance towards FDI. (Shiralashetti and Hugar 2009)

In 1991 however, India had constraints gradually eliminated on investment ventures relating to the industrial sector as well as business expansion, and permitted greater access to foreign equipment and finance. In 1998 and 1999, the government introduced reforms through: financial alliance, joint schemes and technical alliances, capital markets via Euro issues, private placements or preferential allotments. All the measures introduced coupled with the sequential financial sector reforms; help generate higher capital account liberalisation in India. (Prasad and Sharma 2012)

Economic growth

Economic growth of a country, especially a developing country, is systematically linked to the inward FDI. This was proposed by John Dunning in 1979 at a conference from ‘Multinational Enterprises from Developing Countries’ (Dunning and Narula 1996).

Massive amounts of investment capital, along with superior technologies and highly skilled labour are some of the key factors necessary to influence strong economic growth in any country. FDI helps provide technology and expertise, especially needed by developing countries. (Dondeti and Mohanty 2007)

FDI is argues to encourage economic growth, but the degree to which any country profits from FDI rests on the expertise of its labour force, trade policies and absorptive potential. (Hansen and Rand. 2006)

Pradhan (2008) conducted an empirical study in India on the relationship between economic growth and FDI between the period of 1970 to 2004. The author’s findings revealed that it is not FDI that promotes economic growth, but instead economic growth that promotes FDI. The conclusion for this study was that FDI may affect economic growth indirectly via productivity spillovers as well as export spillovers effect, and that the reason for FDI not increasing economic growth may be due to reduced FDI inflows, that is attributed to high tariff barriers, low openness and slow financial integration. However, as mentioned above in the India’s FDI policy framework section, the change in India’s policy framework between 1973 and the 2000 era showed a direct increase in the amount of FDI inflow into India. Therefore, Pradhan (2008) does show make sense in explaining the relationship between FDI and economic growth.

Strong FDI inflow and strong economic growth go hand in hand, however they affect each other. Despite, India’s economic growth slowing down during the global recession in the 2008 to 2009 era, quick recovery took place and the economic growth was eight percent during the 2009 to 2010 period and then at a slightly higher rate again from 2010 to 2011 period. Estimates for such growth to continue are expected, and India’s position as the second fastest growing country in the world shows the impact FDI has played on economic growth. (Ernst and Young 2012)

Employment and Human Capital

FDI is argued to play a positive impact on the training as well as employment opportunities of citizens of the host country. (Ram and Zhang 2002)

Mahmoud (2011) conducted an empirical investigation on the indirect relationship between foreign direct investment and increase in employment in 62 countries, which proved that FDI appears quite often as a major source of employment. This is quite a strong statement to be made on the effect of FDI on the employment of host country employees.

FDI was reported to have a direct increase employment in the country during the period of 1991-2010 especially in the private sector where the government allowed FDI, but not in the public sector which showed a decrease in employment and one of the major factors the decreased employment was attributed to was not allowing FDI in the public sector. FDI guaranteed increase in employment opportunities through helping set up a number of industrial units in India. (Prasad and Sharma 2012)

Technology Transfer and Productivity Spillovers

In order for FDI to take place, the MNC’s must possess some firm specific advantages in comparison to the firms present in the host country, which in turn would result in technology transfer from the parent firm to its subsidiary in the host country, and generating related spillover effects. (Gorg and Strobl 2001)

FDI has been deemed as one of the most vital channels of technological diffusion, for example, in 1995, over 80% of global royalty payments were made from subsidiaries to their parent companies. However, despite the hefty price, the importance of this diffusion cannot be overstated as it enables new technologies, expertise, productivity spillovers from the MNC to the host country, all helping economic growth. (UNCTAD 1998.)

Technological spillovers take place through three different channels, when concerning FDI. The first one concerns the backward linkages with suppliers, as the impact on the domestic firms depends on the measure of dedication present between the MNC and its supplier, as well as how enthusiastic the MNC is to share this knowledge. The next channel concerns linkages with technological partners, which included equity and non-equity agreements. The last channel is forward linkages with customers, involve promotion channels whereby the MNCs contract out the supply of brand name products, next with industrial buyers, and finally MNCs that create commodities (UNCTAD 2000).

It has been noted so far that technological transfer is something that will definitely take place through FDI between the MNC and the host country, but the relationship to productivity spillover can best be summed up by Lesher and Mirodout (2008) who argue that spillovers as an increase in productivity of domestic firms which occurs as a result of foreign firms being present in the host country, through technological transfer, expertise and management skills, all contributing to productivity of the domestic firms and thus being referred to as productivity spillovers.

When considering how exactly the technological transfer and productivity spillovers take place, we have to consider the forms of spillover, and that is both horizontal as well as vertical. Horizontal linkages occur due to intra-industry relationships, whereas vertical spillovers occur due to inter-industry relationships. This will be discussed below better.

(Anwar et al. 2010)

Horizontal spillovers take place when domestic firms are able to profit out of foreign firms working in the same industry. This can occur through a variety of ways such as labor movements, demonstration effects or even through direct competition. Vertical spillovers on the other hand refer to spillovers through, for instance, relationships between MNCs and their suppliers of intermediate inputs. (Wang and Zhao 2008)

The demonstrative effect mentioned above basically describes that local firms are able to learn advanced forms of production as well as obtain managerial skills and expertise from MNCs operating in the market. This happens to have its positives as well, as MNCs are important for bringing advanced technologies that diffuse into the market, but also help strengthen global communication channels, thereby making demonstrative effects across international borders a possibility for domestic firms. (Swan 1973) However, demonstrative effect more often than not is in direct relation with the second spillover effect, and that is competition. This is because when MNCs and domestic firms produce similar goods for the same marketplace, domestic firms will over time adopt production techniques similar to the MNCs, especially if it means their survival, for instance, foreign MNCs in Kenya introduced mechanized production in the soap industry, and due to increased firm rivalry, domestic firms were unable to sell handmade soap in the changing market, so had to adopt the MNCs techniques to survive. (Langdon 1981) Domestic enterprises adopting techniques from MNCs is known as a market stealing effect, and has its own disadvantages for the domestic firms, as the MNCs will now be able to hinder the domestic firm’s chances of gaining economies of scale. Also in markets where there is limited scope for positive spillovers, negative impacts will rise with foreign presence therefore causing spillover benefits to either stagnate or decline. (Harrison 1996) Many domestic firms who depended significantly on technology brought in through FDI instead created a negative impact on independent knowledge creating as well as management skills in the host country (Qi and Li 2008

Labor mobility effect is whereby MNCs train staff members, that decide to move on to domestic firms thereby bringing their expertise and technical know-how with them to domestic firms and propel their knowledge-creation, or even create domestic firms of their in the same market segment that competes against the MNC. This was explained by Qi and Li (2008) who went on to conduct an empirical study involving 28 manufacturing industries in China between the years of 2001 to 2005, and proved that while demonstration and labor mobility effects proved valuable, competition was disadvantageous.

The next form of spillover is Vertical productivity spillover which occurs though the backward and forward linkages, details of which were described earlier in this section from UNCTAD (200). Evidence of productivity spillovers relating to backward linkages was proved by Blaclock (2002) in Indonesia whereas that of forward linkages was proved by Javorcik (2004) in Lithuania.

The three forms of vertical spillovers are: continual transfer of knowledge from MNCs and their parent companies (for example, through training courses), through technological spillovers, and finally through incentives due to fierce competition (e.g. domestic firms are able to raise productivity which is independent of technology used in the foreign firms). Though spillovers can also occur from domestic firms, the chances they occur among foreign-affiliated firms are much greater due to their relationships with huge foreign parent firms. (Lesher and Mirodout 2008)

However, despite all the information provided here, there are many mixed empirical findings as to whether technological and productivity spillovers from horizontal or vertical linkages positively or negatively affect the domestic firms of the host country as gathered by Anwar and Nguyen (2010), who’s results led them to conclude that whether these spillovers positively or negatively affect domestic firms depends upon characteristics such as their absorptive capacity, which they described meant that the spillover size depended on the extent to which domestic firms respond positively to factors such as technology gap, and availability of human capital. The authors went on to argue that the smaller the technological gap between the foreign and domestic firms, the more the domestic firms stood to benefit from FDI-related spillovers. Hamida’s (2011) study goes on to proves these findings, as domestic firms with high technological capability benefitted from spillovers more whilst mid & low technology firms benefitted a lot from demonstration effects. Also, spillovers for high & mid-technology firms were largely dependent on their level of human capital.

Impacts of FDI on Indian Automotive Industry

Significance of the Automotive Industry in India

The automotive industry is seen as a central manufacturing segment which not only drives economic growth, but also helps technological advancement and enables learning superior manufacturing methods for domestic industries, due to its deep rooted backward and forward linkages (Humphrey et al 2000). As explained earlier, India decreasing its FDI barriers led to international companies investing in India and driving its economic growth. The importance of the Indian Automotive Industry is that integration into the global value chains of transnational automotive companies has become more and more and more possible with the decrease of FDI restrictions over the years. This has enabled more FDI investment and therefore been a driver of economic growth. (Humphrey and Memedovic 2003)

Source: ACMA (2001)

An example of linkages with other sectors that shows the impact of FDI on the Indian automotive industry can be explained by the transportation industry for instance that comprises of but not limited to commercial vehicles and components, happened to be the fourth largest FDI receiver from the years 1991 to 2006. Furthermore, though majority of the automotive firms in India have been concentrated on sales to the domestic market, some have moved forward to launching construction bases for export of autos and components. FDI inflows in this sector were responsible for seven percent of complete FDI inflows for the period of 1991 to 2006 (Bloodgood 2007).

Impacts on the Automotive Industry

Impacts on the industry has been through the automobile sector, and also extend to its components sector as will which is expected to see a massive increase in investments that will of-course definitely impact the industry positively, and by extension, fuel economic growth of the country. The surge in investments from foreign investors has been reflected in its impact on the industry in terms of employment creation as well as through technological spillovers as will be described below.

Employment and Labor Quality

In terms of explaining the impact of FDI in employment creation in the automotive sector, Indian automotive industry has been viewed by investors as an ideal destination due to the skilled technical labor force, low-cost supplier base and high domestic demand. In fact, the impact of FDI on the automotive sector can be explained by how in 2011, investors that invest in manufacturing projects in India (automotive industry comes under this along with individual machinery, tools and equipment), the automotive industry took the crown of helping create most employment opportunities in the manufacturing projects invested in by foreign investors. (Ernst and Young 2012)

With the rise in competition between domestic and international firms, employees have been receiving better training opportunities from foreign parent companies to help compete on the global scale. (Just Auto 2012) Skilled labour is a necessity especially in the market today where domestic industry leader Maruti Suzuki is falling in shares, whilst facing competition from Volkswagen, Hyundai, Ford and Toyota who is bringing out new models. Furthermore, firms such as Mercedez-benz, Daimler and BMW who are expected to launch a much larger manufacturing segment in India to exploit economies of scale, as well as Sweden’s Volvo’s Buses announcing plans to invest millions of dollars over a five year period to expand its capacity and develop new products (India Autos report 2012), all require cheap and skilled labour and this promises increased employment. Furthermore, increased competition should help create more skilled employees.

Technology Transfer and Productivity Spillovers

Technological transfer from foreign to domestic firms is vital for enhancing the domestic firm’s productivity and in some instances, even staying in competition and not being run over. Hasan (2002)

Technological transfers taking place was a slow process, as initially, when India has restrictive FDI policies before 1991, access to international technologies was restrictive. Therefore the domestic market suffered from old design, archaic technologies and minimal efficiency and production scale till 1991. With banishing of these policies in 1991, entry of major competitors led mounting competition from 1991 as well as introduction of rigorous Euro norms forced existing domestic firms to regularly improve their technology, and Indian component suppliers were forced to adopt international standards of manufacturing and quality practices.

(Balakrishnan 2007) (Singh 2007)

Foreign MNCs unlike the domestic firms, invest a considerable amount of resources in the research-and development and technological enhancement (Griffith, 1999). This led to an increase in competition from domestic firms, and many to survive link with foreign MNC’s in the form of joint-ventures (JVs) or subsidiaries. Transfer of technology and expertise happened when employees were sent by subsidiaries to parent companies, and gained expertise and skills. Also, some of the international MNCs that entered India in 1995 had their suppliers set up subsidiaries in India. 2000 onwards, technological transfer was evident in Indian vehicles in the form of improvement of safety features, pollution policies, and so on, all suited to international standards. McKinsey & Company (2006).

From 1991 onwards, a massive productivity increase for most domestic firms was as a result of payments in the form of royalties to foreign parent companies for technology and expertise whereas the number of firms performing research–and-development was on a massive decline. Productivity spillovers was evident when considering the growth rate of the Indian automotive industry increasing by 6.2 percent between the 1980s to 2003 in all sectors, in its fixed capital and with increase in total earnings as a result of auto-component exports as well (Okada 2004).

However, FDI related spillovers do not always have positive effects, and in other related industries such as the manufacturing industry, evidence exists that productivity spillovers are negative on large Indian domestic firms. (Kathuria 2000)