The law of unintended consequences says that any policy will typically have consequences not foreseen by either its proponents or critics. Douglas North, the Nobel Prize-winning historian, says successful policy-makers are those who have made shrewd guesses and benefited from unintended, but beneficial consequences.
The most unexpected and unintended consequence of economic liberalisation since 1991 is that foreign investors–multinational companies investing in new factories as well as portfolio investors buying equities on the stock market–have been channelling around $ 4 billion a year on average into India with virtually no return on their investment. In due course these companies will make money, I am sure. But the fact remains that right through the 1990s, India received a flood of “free” money from some of the most hard-nosed, profit-conscious investors in the world. This is one reason why our foreign exchange reserves are in good shape despite fiscal deficits that are as high as in the 1980s.
People of all ideological shades believed in 1990 that opening the doors to MNCs would give them access to a highly profitable market. The Left had long claimed that MNCs made exorbitant profits, much more than local firms, so that an inflow of foreign investment would cause a huge drain of profits out of the country, which we could ill afford.
The Left was not alone. A free trader like Jagdish Bhagwati of Columbia University explained in a well- known paper how foreign investment could immerserise a highly protected country. If tariffs are low, nobody can make high profits because of competition from imports. But if tariffs are high, efficient producers with global advantages can make monopoly profits arising out of the lack of competition from imports. Attracting foreign investment in such conditions can mean getting dollars at a crippling cost.
Nine years after the reforms began, India’s import tariffs remain among the highest in the world. So you might think that foreign investment in such conditions should generate bumper profits, to India’s detriment. After all, the prevailing wisdom in the 1980s was that Indians had, in VS Naipaul’s words, a “craze for phoren”, and would pay irrationally high prices for foreign brand names.
Instead, some of the biggest MNCs have suffered huge losses after years of operations in India. Coke and Pepsi have lost money continuously since inception. India is the biggest consumer of cereals in the world, but Kelloggs cannot sell breakfast cereals at a profit. The biggest car companies in the world have come here–General Motors, Ford, Honda, Fiat, Hyundai, Daewoo, Mercedes Benz–and all have lost fistfuls. Peugeot burned its fingers so badly that it packed up and left. McDonalds says it is progressing well, but has yet to make money. In consumer goods, companies like Sony, Whirlpool, Samsung, Gold Star, Sharp Reebok and Ray Ban, have all lost money in the 1990s.
Why did liberalisation in a protected market immerserise the MNCs rather than India? First, Indians do not have an irrational “craze for phoren”. In past decades the rupee was highly overvalued so foreign goods looked a bargain, and this was a highly rational preference. But today, easy foreign travel has dulled the novelty of foreign brand names, while a realistic exchange rate has made foreign goods look too expensive to be cost-effective. In these conditions, the savvy Indian consumer has proved he will reject foreign goods unless the pricing and marketing is really right.
Kelloggs tried to sell corn flakes at five-times the price of Champion corn flakes, and failed. Coke and Pepsi switched from a 250-ml bottle to a 350 one to try and increase sales volume, but in the process raised the price per bottle so high that demand never really took off.
So, while MNCs have a lot of skills, they also suffer from bloated egos and the mistaken impression that marketing strategies which succeeded elsewhere, will succeed in India too. In fact, India is a tough market, the Indian consumer is highly sensitive to price and quality, and cannot be taken for granted.
Second, the judgement of foreign portfolio investors has proved quite flawed. India has been an economic success in the 1990s, yet foreign portfolio investors have failed to make significant profits. The Sensex today is near 3,900 at an exchange rate of around Rs 47 to the dollar. Remember the same Sensex was above 4,000 in 1992, when the exchange rate was Rs 31 to the dollar. So in dollar terms, the Sensex has actually lost value even as foreigners have poured billions into the market. Foreigners have gone through various fashions in investment, such as new issues, public sector shares, non-financial companies, fast moving consumer goods, technology-media-telecom, and so on. But booms in each of these sectors have been followed by slumps. Many foreign fund managers have performed worse than desi ones, proving again that making money in India is no picnic.
Third, competition can reduce profit margins to zero even in a protected market, something Bhagwati did not fully anticipate. Marketing gurus now emphasise market share over immediate profits: You must rush into a new market and occupy some space even at a loss, because if you wait for the market to become profitable, you may find all the space occupied by rivals. This is why so many foreign companies are prepared to suffer losses for years: They want to establish market share. In this milieu, competition from imports ceases to be critical: There is fierce competition between foreign investors, and between them and Indian companies. Coke and Pepsi could probably make profits if they did not spend crores on advertising wars, but neither side can afford to let up in the war for fear of losing market share.
None of this could be foreseen when India decided to liberalise in 1990. Yes, we all knew that in theory, liberalisation should mean more competition and a better deal for consumers. But given the half-baked nature of reforms, most of us thought that fat margins would be available to foreign investors. We were all wrong.
I now appreciate the wisdom of North. Success in policy is not just about reaping predictable benefits, it is also about releasing forces that can produce unpredictable and unintended benefits. Release the genie of competition, even through the most half-baked liberalisation, and you will get all sorts of unintended beneficial consequences.