MOHAN GURUSWAMYDISTINGUISHED FELLOW

OBSERVER RESEARCH FOUNDATIONNEW DELHI.

FDI in Retail: Reforming or Deforming the Economy?

20/8/2012

1

Mohan Guruswamy ORF

The importance of FDI.

Foreign investment is generally beneficial as it creates jobs, adds value, and contributes to the GDP. Companies like Hyundai, Ford and Honda have built a giant automobile industry in India now producing over 2 million cars and tens of thousands of new jobs. By 2017 India will emerge as the third largest car making country in the world producing over 7 million automobiles. This would not be possible without foreign investment, technology and leadership.

In sector after sector foreign investment has created huge new

capacities catering to domestic and foreign markets. The level of foreign ownership makes little difference to the contribution foreign companies make to the economy.

The desirability of foreign investment must never be questioned as long as it creates jobs, adds value and contributes to development. And these are just the factors that go against foreign direct investment in retail.

20/8/2012

2

Mohan Guruswamy ORF

Reform or deform?

20/8/2012

3

Mohan Guruswamy ORF

Studies in developed and developing countries alike have shown that big box retail rather than creating jobs, destroy jobs. In fact their utility in developed economies is due to the labor savings they achieve.

Classical economics was wary of the monopolistic producer who would charge ‘too much’ from the poor working classes while producing the much-needed ‘bread’. The single producer was the dread from which economists sought ‘perfect competition’, meaning many producers catering to many consumers resulting in fair competition in a perfect market.

Adam Smith could never have conceived of a global operator with a huge hoard of cash and instant information becoming a ‘sole’ consumer.

The MIT Dictionary of Modern Economics defines a monopsonist as “the sole buyer of a factor of production.”

The danger of Monopsony.

20/8/2012

4

Mohan Guruswamy ORF

Monopsony squeezes producers.

The bulk buying and the recourse to monopsonic practices result in pushing down producer prices, with resultant benefits to the consumer. In turn, the more of a commodity large retailers purchase in bulk, the lower the prices growers of agricultural commodities obtain. Studies by FAO and Oxfam attest to this.

For instance, a decade ago coffee growers earned $10 billion from a

global market of over $30 billion but now they receive less than $6 billion out of a global market $60 billion.

The cocoa farmers of Ghana now receive only 3.9% of the price of a typical milk chocolate bar but the retail margin hovers around 34.1%.

A banana farmer in South America gets 5% of the retail price of the banana while 34% accrues to distribution and retail.

20/8/2012

5

Mohan Guruswamy ORF

Coffee prices and exports trends 1980-2000

20/8/2012

6

Mohan Guruswamy ORF

The biggest component of Services.

According to the Planning Commission’s latest data tables this sector employed 47.8 million persons in 2004-5 and has posting impressive growth. In 2000 it employed only 39 million, making it one of the fastest growing employment sectors. It seems that given the lack of opportunities, it is becomes almost a natural decision for an individual to set up a small shop or store, depending on his or her means and capital. And thus, a retailer is born, seemingly out of circumstance rather than choice.

http://planningcommission.nic.in/data/datatable/0211/data%2049.pdf

20/8/2012

7

Mohan Guruswamy ORF

Investing on educating the Indian policymaker!

As per the lobbying disclosure reports filed by Walmart with the US Senate, it has spent an amount of over $11 million (more than Rs 60 crores) on issues related to India, as also other matters, in over two years now. 

It has disclosed “discussion related to India FDI” as one of the issues in its lobbying with the US lawmakers in the first two quarters of 2011, during which it spent nearly USD 4 million (about Rs. 26 crores) on various lobbying activities. 

Quite clearly Walmart carefully prepared for its assault on India’s public opinion. According to the Times of India it got its international PR agency, Burson Marsteller, to acquire a well-known Indian PR and lobbying firm, Genesis, in 2006.

http://blogs.rediff.com/dillichaat/2011/12/07/did-wal-mart-spend-a-fortune-lobbying-for-india-entry/

20/8/2012

8

Mohan Guruswamy ORF

Rahul Gandhi, told election gatherings across Farrukhabad and Kannauj in UP that FDI would solve the puzzle of a kilogram of potato fetching Rs 2 or less to the farmer and a packet of potato chips costing Rs 10. "A packet of chips is made from just half a potato," he added, virtually turning the opposition to FDI into a conspiracy against farmers

20/8/20129Mohan Guruswamy ORF

A recent joint study in Finland by Agrifood Research Finland and Pellervo Economic Research Institute reveals that for each kilo of rye bread purchased in 2010, for which the consumer paid 3.52 Euros, 1.24 went to the seller, while the grower received only 14 cents. A further 1.74 Euros were shared by the milling company and logistics, while the rest went to the state as taxes. The study also revealed that while the trade got 19% of the takings on food in 2000, it went up to 29% in 2009.Another Finnish study revealed that while basic raw material costs declined, the cost of the finished product kept increasing.

20/8/201210Mohan Guruswamy ORF

Selective amnesia leading to selective use of data?

Protagonists of FDI in retail talk a lot about modernizing the supply chain and reducing wastage. They cite a study by the management consultancy firm Price Waterhouse and Coopers to suggest that a huge quantity of food (24-40%) is wasted due to the inadequate and primitive supply chain in India.

PWC seems to be selectively deriving this from the FAO study cited later here, which in fact reveals that the level of wastage in both, the developed and developing countries is in the same range.

Nevertheless the same study suggest that South Asia is indeed very frugal about wasting food before and after reaching the consumer.

20/8/2012

11

Mohan Guruswamy ORF

From “Global Food Losses and Food Waste” by Jenny Gustavsson, Christel Cederberg and Ulf Sonneson of Swedish Institute for Food and Biotechnology (SIK) Gothenburg, Sweden, and Robert van Otterdijik and Alaxandre Meybeck, FAO, Rome, Italy. Chapter 3, pp 5.

20/8/201212Mohan Guruswamy ORF

Look at who is wasting food?

20/8/2012

13

Mohan Guruswamy ORF

India’s agri-business. The world’s second largest. $ 157.17 billion in 2009. Low productivity.

20/8/2012

14

Mohan Guruswamy ORF

But before we get into the 'for and against' argument vis-à-vis FDI, we must also ponder over the fact that a modern and nationwide supply chain has been created, indigenously, for milk and milk products which account for 8.11% of household expenditure.

Similarly we have an effective supply chain for food items such as cereals, pulses, and sugar and edible oils, which together account for 24.16% of household expenditure.

All other non-food goods purchased by our households such as tobacco products and alcohol, processed foods and snacks, toiletries, detergents, garments etc which together account for 52.57% of all urban household expenditure are made available for consumption by modern and efficient supply chains.

The fact is 84.8% of household all purchases including food comes from modern supply chains. Walmart etc. presumably will come here to modernize the 15.2% left out?

20/8/201215Mohan Guruswamy ORF

Trickle down economics at its best!

According to Global Exchange, workers on coffee plantations are generally paid between $2 and 3 dollars a day. Guatemalan plantation workers must pick 100 pounds of coffee in order to get the minimum wage of just under $3 a day. Workers are often forced to bring their children to ensure they meet their quota.

Meanwhile small family farmers earn between $500 and $1,000 a year. Family farmers’ low earnings are typically a result of their being forced to sell their product to middlemen at sometimes half the market value.

That the big companies buy from primary producers is not established by experience in India and elsewhere. (Reliance, ITC, Pepsi Foods etc.)

The average size of a landholding in India is now about 0.66 hectares. Less than 1.6% of land holdings are larger than 10 hectares, which is about the size of holding which will support the modern methods and high standards demanded by a corporate buyer.

These large holdings account for 13.83% of the total farmland in India and comprise 1,654,000 households.

1. David Hoyt and John McMillan. 19 February 2004. “The Global Coffee Trade.” Stanford Graduate School of Business. 2.Fertilizer Statistics, 1999-2000, The Fertilizer Association of India. 3. 48 NSS Round (1991-92)

20/8/2012

16

Mohan Guruswamy ORF

No escaping the middleman.

TIME magazine commented: “The Indian food supply is so vast and so neglected (most farmers don’t even have irrigation, let alone access to cold storage) that there is room for all of these players. Even if Walmart reaches its goal of building a network of 35,000 farmers by 2015, that’s a tiny fraction of India’s labor force of 450 million. India might be the only place in the world where even Walmart has trouble achieving scale.” The sheer number of farmers and their smallholdings makes middlemen inevitable. The middlemen do more than just buy. They are more often than not the farmer's main creditor, a task that the big corporate buyer will be loath to undertake.

TIME, “Why India Should Stop Fearing Walmart”, By Jyothi Thottam | November 28, 2011

20/8/2012

17

Mohan Guruswamy ORF

The Great Walmart of China!

“More than anything else it is Walmart's Chinese connection that should cause us to worry. While Walmart has 352 stores in 130 Chinese cities with a total turnover of $7.5 billion, Walmart directly buys via its procurement centers at Shenzhen and Dalian over $ 290 billion worth of goods from more than 20,000 Chinese suppliers, 70% of its 2010 worldwide turnover of $420 billion.”

The Atlantic, December 2011 pp82

20/8/2012

18

Mohan Guruswamy ORF

The ugly reality of US economic power.

A good example to demonstrate the low wages in the Chinese labour market is contained in a report by Thomas Fuller in The International Herald Tribune of August 3, 2006, which investigated the percentage split in profit in the shoe industry between the Chinese factories and those who market and sell the finished products in the US and Europe. The factory owners after the laborious process of manufacturing makes a profit margin of 65 cents per pair of shoes, which are sold ex-factory for $15.30.

“A major U.S. retailer, after factoring in shipping, store rent and salaries, sells

the boots for $49.99. Assuming a pretax profit margin of about 7 percent, an average among large U.S. retailers, it earns $3.46 on the same pair of boots.” However the story doesn’t end with the unfair profit margins. The Chinese laborers, who make the shoes, box them and even affix the price tag, are the ones who get the worst deal. Yet for all the sweat that goes into making shoes in Tianjin, the factory payroll is equivalent to $1.30 a pair, 2.6 percent of the U.S. retail price.” Should the salary of every worker in the Chinese shoe factory be doubled, the retail price in the US would merely go up from $49.99 to $52.29.

  “Billions in trade gap, pennies for workers” - Business - International Herald Tribune By

Thomas Fuller, published: Thursday, August 3, 2006

20/8/2012

19

Mohan Guruswamy ORF

The Walmart pipeline.

“One way to think of Walmart is as a vast pipeline that gives non-U.S. companies direct access to the American market.”

"One of the things that limits or slows the growth of imports is the cost of establishing connections and networks.”

"Wal-Mart is so big and so centralized that it can all at once hook Chinese and other suppliers into its digital system. So--wham!--you have a large switch to overseas sourcing in a period quicker than under the old rules of retailing.”

So says Paul Krugman, the famous Princeton University economist.

20/8/2012

20

Mohan Guruswamy ORF

What the flow of cheap Chinese goods through the Walmart direct pipeline from China into India will do to Indian companies, particularly the SME’s can well be imagined.

Even without Walmart, Indian SME’s are being driven out in sector after sector by cheap Chinese imports. For instance there is no light fittings industry left in India. Same for toys. One can well imagine what a Walmart pipeline will do to the hosiery and woolen goods manufacturers in Ludhiana and Tiruppur? The once prosperous clock making industry around Rajkot has almost entirely fled to China.

In 1985 Sam Walton, the founder of Walmart was forced to say: “Something must be done by all of us in the retailing and manufacturing areas to reverse this serious threat of overseas imports to our free enterprise system… Our company is firmly committed to the philosophy by buying everything possible from suppliers who manufacture their products in the United States.”

India should also be worried about its fast growing trade deficit with China, now likely to exceed $40 billion.

The contribution of industry to GDP in 1992-96 and 1997-2003 was 30.9% and 23.7% for India, while for China over roughly the same period it was 62.2% and 58.5%15.

Inviting problems from abroad?

20/8/201221Mohan Guruswamy ORF

Revolution in retail, or retailing revolution?

The US or European experience shows that retail giants destroyed the livelihood of small shopkeepers, who became employees of such giants for paltry salaries. A retail supermarket encompasses the entire chain and shrinks the intermediaries – lowering costs and removing jobs.

In a country with no social security net – the replacement of thousands of retailers by a single large intermediary will shrink jobs by the millions in distribution industry. What option will these millions have then except to take to the street?

Many talk of the revolution in retail, but the government

must now be more concerned with revolutions brewing on the streets.

20/8/2012

22

Mohan Guruswamy ORF

A FDI in retail policy that will work for all

stakeholders.

There are ways of achieving the former while avoiding the latter.

3 simple suggestions to tweak the policy on the anvil are: 1. Insist that big box retailer’s be foreign exchange

neutral. That is, they export as much as they import. 2. Restrict big box retailers to outside municipal limits and

to satellite towns instead of restricting them to within the 53 cities with more than a million people each. This will ease the urban chaos and encourage people to move into less expensive housing outside the big cities.

3. And finally, why put limits on foreign equity holdings? Allow companies like Walmart to own 100% of their business in India. At the same time the government must insist that they bring in foreign loans to finance their entire capital investment in India.

20/8/2012

23

Mohan Guruswamy ORF

Understanding the nature of the beast.

Above all the policy maker must realize that while it is an American corporation earning profits for its US shareholders, Walmart is mainly a retailer of Chinese goods. Its business model is quite unique.

As Nick Robbins wrote in the context of the East India Company, “By controlling both ends of the chain, the company could buy cheap and sell dear”

In this case it means profits for the Americans, jobs for the Chinese.

20/8/2012

24

Mohan Guruswamy ORF

20/8/201225Mohan Guruswamy ORF