COMPARATIVE STUDY OF FOREIGN DIRECT INVESTMENT IN INDIA AND USA, Thesis of Civil Law

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VOLUME 2 ISSUE 1 & 2

APRIL & NOVEMBER

FIMT

LAW JOURNAL

COMPARATIVE STUDY OF FOREIGN DIRECT INVESTMENT

IN INDIA AND USA

Hrishikesh Prakash Jaiswal* Foreign Direct Investment is one of the widely discussed topics in recent times. FDI takes place when a foreign company takes the controlling ownership in a firm which is located in the domestic country. FDI is not limited only to money it brings, but also the skills, technology and knowledge the foreign firms bring along with them. In this liberalized era, capital from foreign countries has assumed a great deal of importance in expediting commerce and trade activities of a country and increasing its international trade. In this paper, we will mainly discuss and compare the position of FDI in India and the USA. The present study highlights the advantages of FDI and the country-specific factors that either attract or repel foreign investments. In the subsequent parts, we will compare India and the USA on the basis of certain parameters such as Top sectors of attracting FDI inflow, Top investing countries, FDI flows and stocks in India and USA, GDP expectations and FDI restrictiveness. INTRODUCTION Foreign Direct Investment (FDI) is one of the most important tools of globalization. In this liberalized era, capital from foreign countries has assumed a great deal of importance in expediting commerce and trade activities of a country and increasing its international trade. In recent times expansion of foreign investments has proven to be an impetus for investment in developing and emerging economies. Foreign Direct Investment brings the foremost needed capital, improved social and managerial skills, up-to-date technology, and the latest marketing techniques. Since the early 1980s, almost all the economies have been trying to get FDI by deregulating their policies and placing reliance on the market forces. FDI is an indispensable tool for the growth and economic well-being of a state. Backward and orient economies focus on improving their FDI position to be able to achieve growth. Foreign Direct Investment not only promotes capital formation but also because it can attract the huge value of the capital stock.^1 As new foreign companies enter the market, they bring along with them the latest and efficient technologies which has a spillover effect on the domestic firms making them more

• (^) Mr. Hrishikesh Prakash Jaiswal is a III year B.A.LL.B. student at NLIU, Bhopal. (^1) George H. and D. Greenaway, ‘On whether Domestic Firms benefit from Foreign Direct Investment’ (2004) 19(2) Internationalization of Labor Market 171.

institutional units engaged in production”.^6 GDP = Consumption + Investment + Government Spending + (Exports - Imports).

Gross National Product (GNP)

GNP is the total value of all the final goods and services produced and supplied by the citizens of the country. GNP = GDP + NR (Net income inflow from assets abroad or Net Income Receipts) – NP (Net payment outflow to foreign assets). The economic growth of a country is heavily dependent on the prevailing rate of interest which in turn is hugely dependent on foreign investments. FDI acts as the primary source of capital to bridge the gap between savings and investment. International & transnational trade and FDI are the major driving force of any economy. Various empirical studies have been done on the subject of the relationship between FDI and economic growth, and the majority of them rule that FDI and economic growth have a positive correlation while some conclude the opposite. In recent studies, it has been said that the effect of FDI on economic growth is not traditional in nature but varies from country to country. IMPORTANCE OF FDI Now we will discuss the benefits of FDI to both the host country as well as the countries from which the investments are being done.

Technology Transfer: Various FDI scholars are on a consensus that one of the most

vital positive externality of foreign company existence and FDI to the receiving country is the technology they bring along with them. Multinational corporations are known for their well-developed and high budget Research and Development (R&D) departments^7. These companies spend a huge chunk of their deep pockets on research work, incorporating the latest and finest technology in their working. It has been observed in many cases that home companies tend to use obsolete technology in their operations and thus the presence of MNC’s becomes important. Foreign companies are having the potential for significant technology spillovers. But, it has been observed that the effect of such spillovers highly depends upon the type of country and sectors. (^6) Doreen Fagan , Public Affairs Staff, ‘What is GDP, and why is it important’ (2019) Open Vault Blog, https://www.stlouisfed.org/open-vault/2019/march/what-is-gdp-why-important.asp. accessed on 5 May

(^7) Chanda and Rupa, ‘ Services led growth ’ (2nd (^) edn, TNOCEI 69 2012).

Competition with Domestic Firms : The entry of foreign firms and multinational

enterprises exert a considerable impact on the competition in the domestic country. There are various shreds of empirical evidence that entry of MNCs directly as well as indirectly increase the economic development of the receiving country. This happens because competition for the domestic firms increases which leads to greater economic development. Increased competition forces the domestic firms to increase their productivity by applying efficient and effective technologies which lead to an overall reduction in the prices of the goods and services produced. Conversely, the increased competition might hurt the small and medium businesses of the domestic country as they are mostly labor-intensive and low on budgets, and thus, they are not able to cope up with the dynamic and fast-changing technological environment and they tend to crumble down.^8

Human Capital Development: The most unrealized and unrecognized benefits of

investments from a foreign firm is the enhancement it provides to human capital. The effect which FDI provides to the labor force of a country is indirect and unintentional. This takes place not by the efforts of the MNCs but because of the changing policy framework by the state. The governments of Underdeveloped and Developing states are aware that enhanced human capital provides an incentive to the huge foreign companies to come and invest in these economies and exploit their skilled as well as unskilled labor.^9 The biggest and most vital human capital investment is the investment in general education. This creates an environment that attracts the cash-rich countries to invest in developing countries. Only those countries which are able to provide an anti-discriminative and socially secure environment are successful FDI recipients in today’s world. When the workers are employed by foreign firms, they are further given on-the-job training and learning which additionally enhances the human resource. Further, the enterprises which are linked to the MNC also get the positive ascendancy of the enhanced human labor. Other companies and businesses try to replicate the MNC model in their working area which enhances the human capital of these enterprises. Thus, the issue of human capital development is intimately related to other broader development issues.

Increased International Exposure: Though the effects of FDI are differently felt by

different economies, a consensus can be drawn at this juncture that long term FDI has a positive impact on the exports and imports of the domestic state. The main benefit of (^8) Dierk Herzer, ‘Outward FDI and economic growth’ (2010) 37(5) Journal of Economic Studies 476. (^9) Wang, M., ‘Manufacturing FDI and Economic Growth: Evidence from Asian Economies’ (2009) 41(8) AE 991.

majority in America. Governments of both countries are secular and follow a system of affirmative action for Scheduled Castes, Scheduled Tribes and other Backward Classes in India and for minorities and women in the US. It is also believed that both countries have a common enemy which is China.^11 FOREIGN DIRECT INVESTMENT IN INDIA To define, Foreign Direct Investment is a type of investment by a company that is located not in the domestic country but some foreign state by buying a company or putting money into an already existing company in the domestic country. After the 1980s, the world economy has entered into an era of globalization and FDI acts as a major influencer^12. FDI is now playing a major role in the economic development of any country, especially a country like India because capital has always been an issue in developing countries. The world is globalizing and developing countries are opening their economies to bag investments for capital abundant countries while the developed economies are in a search for new and unexplored markets, cheap labor and huge profits. Therefore Foreign Direct Investment (FDI) has become a battleground in the emerging markets.^13 The development of the Indian economy depends a lot on foreign investments. FDI in a nation basically depends upon the investment and saving rate of that country and the gap between investment and saving is fulfilled by FDI. Today, India is recognized and known as a world hub for FDI due to its cheap skilled human capital and huge potential markets. India has had record-breaking GDP growth rate figures in the recent past which has helped millions to come out of poverty. A recent UNCTAD survey projected India as the second most important FDI destination after China for transnational corporations during 2010-2015.^14 The major FDI attracting sectors in India are telecom, computer engineering, services, automobile etc. while the top investing countries are Mauritius, Singapore and USA. HISTORY OF FDI IN INDIA Throughout history, India has always adopted a prudent and careful mindset while deciding the FDI policy and has relied on the ‘import-substitution strategy of industrialization’. The then Congress government had brought in the FERA Foreign Exchange Regulation Act 1973, under which only Joint Venture foreign companies were allowed to hold equities up to 40 percent. This policy was not very successful and thus (^11) Chandhoke N, ‘ Negotiating linguistic diversity: A comparative study of India and the United States ’( 1st (^) edn, Oxford University Press, 2002). (^12) K. Bajpai, ‘ Democracy and diversity: India and the American experience ’ (1st (^) edn, Oxford University Press, 2000). (^13) Abhishek Vijay Kumar Vyas, ‘An Analytical Study of FDI in India’ (2015) 5(10) IJSRP 41. (^14) Ibid, 52-53.

certain relaxations were given to the foreign holdings, which were now allowed to own 40 percent equities in high technology export businesses. The flagship event in FDI history was the establishment of Special Economic Zones (SEZ) across the country to encourage foreign firms to invest in Indian markets. The major foreign policy announcements came in the years 1980, 1982 and 1983 which displayed the liberal side of the government. The new policy had the provisions of delicensing and promotion of exports in the manufacturing sector. The tariff raj was slowly being dismantled and a system of Open General Licensing was made the new normal. The major breakthrough came in the year 1991 when the Indian government undertook the economic liberalization program. This was done not out of comfort but with serious pressure from International monetary organizations like IMF and World Bank. The 1991 Industrial policy aimed at integrating India with the world economy. Several measures taken in this regard are listed below.^15 The government signed the Multilateral Investment Guarantee Agency (MIGA) treaty for protection of FDI. High priority sectors were brought under automatic permission route and restriction on technology imports for low technology industries was made nil. Now, Non-resident Indians could invest up to a hundred percent in certain important sectors. 2 types of investment routes were introduced i.e. FDI–RBI’s automatic route and Government’s approval (SIA/FIPB) route Hike in the foreign equity participation limits to fifty-one percent for existing corporations and liberalization of the use of foreign “brands name” The major highlight of India’s Liberal FDI policy is the enactment of Foreign Exchange Management Act 1999 making the earlier act defunct. In 2006, the government allowed fifty-one percent FDI in Single-brand retailing which was later amended and the new figure was hundred percent in Single-brand and fifty-one percent in Multi-Brand retailing. FOREIGN DIRECT INVESTMENT ROUTES UNDER THE 1991 SCHEME

Government Route : The sectors which do not fall within the ambit of the automatic

approval have to pass the government route through the Ministry of Finance and Foreign Investment Promotion Board. (^15) Sharma R. & Khurana N., ‘Role of Foreign Direct Investment (FDI) in Different Sectors’ (2013) 2(1) IJAME.

CAUSAL FACTORS FOR FDI IN INDIA^17

Different countries have different factors that either attract FDI or discourage foreign investors. In this section, we will talk about various determinants of foreign investments in India-

Skilled and Unskilled Labor: With a population of 1.3 billion, India is land to a huge

bulk of skilled and unskilled labor. The governments have focused on skill development of its mass which is an important attraction for foreign investors. MNCs are looking for cheap labor to cut their manufacturing costs and raise their profits. The West has invested a lot in the Business Processes Outsourcing sector as they were getting English speaking Indian youth to act as online facilitators at dirt cheap prices.

Monetary and Policy Factors: With the coming up of the New Industrial policy in 1991,

the government had given various relaxations and exemptions to potential investors. These were low-interest loans, subsidies, tax holidays and grants etc. MNCs and foreign governments prefer countries that have stable policies and strong governments. India has had stable governments after independence with a few exceptions, of course.

Huge Markets: India has a majority of its market still unexplored. The bulk of the Indian

population is characterized to be middle class which is a potential market for foreign companies. BPO is a great example of this. New Indian is seen as a person who would wear a Nike shoe, have his lunch in Pizza Hut and use an iPhone manufactured in Gurgaon.

Abundant Resources: India was earlier regarded as ‘Golden Bird’, primarily because of

the resources it had. India is rich in natural resources such as iron ore and coal. It has huge water boundaries which provide it strategic access to different countries. MNCs can efficiently utilize these resources using their imported technology. FOREIGN DIRECT INVESTMENT IN USA The United States is considered the ‘big daddy’ in the foreign investment world. America is basically an ‘open economy’ with very low trade restrictions. Multinational Corporations are a source of jobs, capital and technology for America. Since the late 1980s, foreign companies and investors have shown their interest in the American markets and foreign investments have drastically multiplied. Over the last two decades, the number of foreign (^17) Bajpai (n 12) 233- 37.

firms conducting business within the US has nearly tripled.^18 Major investors in the US are from Switzerland, UK, France and Canada etc. America has a lot of factors such as huge market size, fewer trade barriers, and low wages which make it a perfect choice to place one’s bets on. HISTORY OF FDI IN USA From the rule of British to the present time, the economy of the US has been sustaining itself based on investments from abroad. The earliest known investment from the USA was made in an English company named ‘Virginia Company’. Till nineteenth century, most of the businesses in America were indigenous and small scale. Investments from Britain were the only known Foreign Investments in the USA. Things started to change after the American Revolution in 1778. Times changed for the better in the early 20th^ century, when the USA became the world’s largest recipient of non-domestic investments and came to be known as ‘debtor nation’. The only time when foreign investments fell was during the civil wars. In changing times, the only key to remain aggressive and competitive is capital from non-domestic countries. America has emerged as a big boss in the FDI arena, encouraging or sometimes forcing the closed economies to liberalize. The United States has enjoyed a long history of foreign investment, with foreign investors encouraged to participate in trade agreements with the United States since the Louisiana Purchase and widespread industrialization in the 1800s.^19 FDI has been helping the States to develop its economy but many a times it is also perceived as a threat to its national security. During the early 20 th^ century, the US lacked proper legislation on foreign investments. Cross-border trading increased to such an extent that the state was forced to enact trade laws to protect the domestic economy and sovereignty of the country. In the later part of the 20th^ century, the value of the US Dollar depreciated which surged investments from different nations. In 1974, the Study Act was enacted "requiring the Secretaries of Treasury and Commerce to conduct a comprehensive review of foreign investment in the United States."^20 And in 1975, Committee on Foreign Investment in the United States (CFIUS) was formed by the then President. The CFIUS had "primary continuing responsibility within the Executive Branch for (^18) Grosse, Robert & Len J. Trevino, ‘Foreign Direct Investment in the United States: An Analysis by Country of Origin’ (1996) 27(1) JIBS 139. (^19) Paul I. Djurisic , ‘The Exon-Florio Amendment: National Security Legislation Hampered by Political and Economic Forces’ (1991) 3 DBLJ 179. (^20) Deborah M. Mostaghel, ‘Dubai Ports World Under Exon-Florio: A Threat to National Security or a Tempest in a Seaport’ (2007) 70 ALBLR 583.

President Trump has injected uncertainty in the longstanding relationship between America and its age-old trade partners. Countries that earlier used to deal with the US are now looking for other avenues. Protectionist measures announced by POTUS are threatening the integration of the United States with the world economy.

High Corporate Tax: If a company has to do business in the US, it has to comply with

an array of local, state and national taxes. The government is very strict on the imposition and collection of taxes. Corporate tax in the US goes up to 35%, which is the highest among developed countries. Tax and profits have a negative correlation; thus high taxes discourage investors from investing in such countries. Another problem with the US economy is the rising public debt.

Market Behavior: As explained earlier, the basis of FDI is mutual trust. Consumer

Market in the USA is very wide, with all types of customers. One of the important principles of doing business is to create brand loyalty. In simple words, brand loyalty means the trust and assurance that a customer has on the products of a specific brand. US market is flooded with products from all over the globe. Every day, thousands of new products flush the market and all of them have something new to offer, this has made the American consumers accustomed to having many choices.^24 Thus, people tend to become disloyal to brands. This may not seem to be a very paramount problem, but foreign brands are actually in a state of crisis because of this. CAUSAL FACTORS FOR FDI IN USA In the earlier part, we have discussed the determinants of FDI in India. Similarly, we will elaborate upon the factors which make America a perfect place for investing in this globalized world-

Large and Homogeneous Market: USA in the present time is accommodating more

than 300 million people. It has a large and growing market. Most of the Americans are working, and thus it makes them a perfect market for all foreign investors. Per Capita income of an American is 62794.59 USD which is the highest among the top developed economies. The US is the third most populous country in the world after China and India. After the 1975 recession, most of the so-called developed economies have struggled to grow, while the USA’s robust economy has fought the recessions bravely.

Favorable Investment Climate: Today, the world is as dynamic as it could be. The

(^24) Societe Generale, COUNTRY RISK OF THE UNITED STATES: INVESTMENT, < https://import- export.societegenerale.fr/en/country/united-states/country-risk-in-investment> accessed on 10 May 2020.

globalized world is disorderly and unreliable in its nature. As compared to other developed countries, the USA is stable and dependable in its policy framework and labor laws. Foreign investors are favoring the USA because of increased political uncertainty and interference from the home government in their country. The investors fear to invest in developing countries because of the uncompensated expropriations, discriminatory treatment of foreign firms, and sharp shifts in political orientation.

Exchange Rate: Since the 1975 depression, the US dollar value has depreciated which has

driven acquisition of domestic American firms profitable. Major acquisitions were from countries like Japan and Switzerland which were earlier dependent on exports from the US. As the exchange rate fell, exports from the USA became very expensive for the countries that earlier relied on them, but this proved as a blessing in disguise as it made the American assets less expensive.^25

Technology Boss: United States of America is undisputedly the world boss when it

comes to research and development. With thousands of patents every year, America spends its major share of its budget on development of technology. It has the best technology in the sectors of manufacturing and computers. Many countries have acquired the US firms with the sole motto to get access to their technology and applied science. Major acquisitions in the technology sector have been made by Europe and Japan. As long as the United States remains a technological leader in such key areas, and as long as the economic strength of foreign enterprises increases, such acquisitions will continue.^26 COMPARISON AND DATA ANALYSIS We will compare India and the USA through graphs and tables on the following basis  Top sectors of attracting FDI inflow  Top investing countries  FDI outflows, Inflows and stocks in India and USA  Gross Domestic Product and per capita income  Forecast of Real GDP  FDI restrictiveness (^25) Carolyn J. Kubota, ‘Closing the Open Door to Foreign Direct Investment’ (1982) 15 Cornell International Law Journal 15. (^26) Julius L. Katz, ‘Foreign Direct Investment in the United States-- Advantages and Barriers’ (1979) 11(3) Case western journal of International Law 12.

UNITED STATES OF AMERICA-

Table 2- Top Ten Countries Investing in the USA in terms of %

Serial No. Country Percentage of FDI inflows

1 UK 15.

2 Japan 11. 3 Germany 10. 4 Iceland 8. 5 France 7. 6 Switzerland 5. 7 Singapore 4. 8 Belgium 2. 9 Spain 1. 10 Australia 1. Source: OFII: FDI in U.S. 2019

Fig. 2 - Pie Chart Depicting % of FDI Inflows from Various Countries In USA

Findings: In India, Mauritius has been the undisputed leader when it comes to FDI. It

accounted for 31.07 percent (Table 1) of total Foreign Direct Investment in India. One would wonder, why the investments are so high from a small island nation. The reason is that Mauritius has a double taxation avoidance treaty with India. Thus, many companies from China and Germany have been taking advantage of this situation by establishing shell companies in Mauritius, which invest their money into the Indian market.^27 The second largest investor in India is Singapore because of low rates of taxation and various tax (^27) Dr. S.N. Babar, ‘Foreign Direct Investments in India and China: A Comparative Study’ (2014) 1 SSRN Electronic Journal 1. 23% 17% 15% 12% 11% 7% 6% 3% 3% 3% PERCENTAGE OF FDI INFLOWS FROM DIFFERENT COUNTRIES IN USA UK Japan Germany Iceland France Switzerland Singapore Belgium Spain Australia

treaties signed between India and Singapore. United Kingdom is the largest investor in the US (15.2%) (Table2). The mutual investments between the two countries add up to 1 trillion USD. 28 The main reason for such huge numbers is the pleasant historical relationship between both the countries. Also, America is the largest investor in the UK export market. Japan was the second biggest investor in the US; in 2013^29 it invested almost 46 Billion USD in the American markets with the majority of them being in the automobile sector. Japan tends to cater to the large and diversified American automobile consumer market. The other major investors in India are from the U.S.A, Japan, Singapore and UAE etc. Germany, Iceland, France and Switzerland were the top rank holders with 1/3rd^ of the foreign investments in America coming from them.

II. FDI Outflows, Inflows and Stocks in India and the USA: Foreign Direct investment

flow means the annual cross border trade relating to direct investment. FDI is inclusive of intercompany debt, reinvested earnings and equity trade. FDI inflows are the value of all assets and liabilities between the resident direct investment enterprises and their direct investors. Conversely, FDI outflows are the value of assets and liabilities between resident direct investors and their direct investment enterprises. The FDI inflows and outflows are always in net terms i.e. capital transactions credit minus the debits between investors and foreign companies. FDI flows have been calculated in USD and as a share of GDP. FDI stocks are the net value of total direct investment in a county at a particular point of time.

Table 3- FDI Outflow From India and the USA^30

Years India (MLN_USD) USA (MLN_USD)

(^28) Direct Investment by Country and Industry, <https://www.bea.gov/data/intl-trade-investment/direct- investment-country-and-industry> accessed on 25 May 2020. (^29) US Bureau of Economic Analysis, < https://www.bea.gov/data/intl-trade-investment/direct-investment- country-and-industry> accessed on 25 May, 2020. (^30) OECD (2020), FDI flows (indicator), <https://data.oecd.org/fdi/fdi-flows.htmdoi: 10.1787/99f6e393- en> accessed on 12 June 2020.

Source: Benchmark definition, 4th edition (BMD4): Foreign direct investment: financial flows, main aggregate Fig. 4 - FDI Stocks Inward, % of GDP 2019^33 *India and the USA are represented in red and blue respectively. Source: Benchmark definition, 4th edition (BMD4): Foreign direct investment: positions, main aggregates India 14% of the GDP, USA 44% of the GDP

Findings: In 2019 World Investment Report^34 , India was among the top ten economies

receiving maximum FDI. The FDI inflows saw a peak in 2016, with investments around 44.6 billion (Table 4) coming from various parts of the world. India accounts for 70- 80 percent of the total FDI inflows in the South East Asian region. Foreign investments in India have seen a tenfold jump from 2005 to 2019 with the maximum increase in the (^33) (n 29). (^34) United Nations Conference on Trade and Development, ‘ (UNCTAD) 2019 World Investment Report’ 2019 (UNCTAD/WIR/2019).

service sector. The USA is the world’s largest economy. FDI inflows in the US in 2019 were about 260 billion USD, which is slightly lower than the previous year but the major dip was seen in 2018, when FDI fell about 15% from the previous year, reason being fall of one third in cross-border M&A sales. In 2019, US retained the position of the top destination for FDI because of its humongous consumer market, better dispute resolution system and excellent infrastructure. The US FDI stock in 2018 decreased by 4% compared to the previous year, reaching USD 7,464 billion ( Figure 4). FDI inward stocks amounted to 14% of the Indian GDP and 44% of the American GDP while FDI outward stocks amounted to 6% of the Indian GDP and 36% of the American GDP. In 2005, FDI inflows in India and the USA were about 7 and 120 billion USD respectively. When we compare it to 2019 figures, we can very well say that India has done surprisingly well because India has witnessed a tenfold increase in FDI from 2005 to 2019 while the US’s figures increased only three times during the same period.

III. Top Sectors of Attracting FDI Inflow: Here, we will discuss the top 10 sectors

attracting maximum FDI inflows in India and the USA through tables and diagrams.

Table 5- Top Sectors attracting FDI in India and the USA

Serial

Number

Sectors with maximum

FDI in India

Percentage Sectors with

maximum FDI

in the USA

Percentage

1 Service Sector 19 Manufacturing 48. 2 Construction development Computer software and hardware 12 Financial and Insurance

3 Telecommunications 7 Wholesale trade 12. 4 Computer software and hardware 6 Petroleum 9. 5 Pharmaceuticals and Medicines 5 Non-banking companies

6 Chemical and Fertilizers 5 Services 6. 7 Automobile sector 4 Banking 6. 8 Power 4 Information 5. 9 Infrastructure (Metallurgy) 4 Mining 4. 10 Hotel and Tourism 4 Transportation, retail and real estate

Source: OFII: Foreign Direct Investment in US 2018, PIB