Foreign Direct Investment – Is India a desired Destination?

1. INTRODUCTION ON FOREIGN INVESTMENT –

Foreign Investment refers to investments made by residents of a country in financial assets and production process of another country. After the opening up of the borders for capital movement these investments have grown in leaps and bounds. But it had varied effects across the countries. It can affect the factor productivity of the recipient country and can also affect the balance of payments. In developing countries there was a great need of foreign capital, not only to increase their productivity of labor but also helps to build the foreign exchange reserves to meet the trade deficit. Foreign investment provides a channel through which these countries can have access to foreign capital. It can come in two forms:

• foreign direct investment (FDI)
• foreign portfolio investment (FPI)

Foreign direct investment involves in the direct production activity and also of medium to long-term nature. But the foreign portfolio investment is a short-term investment mostly in the financial markets and it consists of Foreign Institutional Investment (FII). The FII, given its short-term nature, might have bi-directional causation with the returns of other domestic financial markets like money market, stock market, foreign exchange market

2. WHY DO COMPANIES GO ABROAD –

1. Host countries with sizeable domestic markets, measured by GDP per capita and sustained growth of these markets, measured by growth rates of GDP, attract relatively large volumes of FDI

2. Resource endowments of host countries including natural resources and human resources are a factor of importance in the investment decision process of foreign firms.

3. Infrastructure facilities including transportation and communication net works are an important determinant of FDI.

4. Macro economic stability, signified by stable exchange rates and low rates of inflation is a significant factor in attracting foreign investors.

5. Political stability in the host countries is an important factor in the investment decision process of foreign firms.

6. A stable and transparent policy framework towards FDI is attractive to potential investors.

7. Foreign firms place a premium on a distortion free economic and business environment. An allied proposition here is that a distortion free foreign trade regime, which is neutral in terms of the incentives it provides for import substituting (IS) and export industries (EP), attracts relatively large volumes of FDI than either an IS or an EP regime.Fiscal and monetary incentives in the form of tax concessions do play a role in attracting FDI, but these are of little significance in the absence of a stable economic environment.

3. FACTORS IN INDIA THAT HAVE ENABLED FOREIGN INVESTMENTS –

How does India fare on these attributes? She does possess a large domestic market, she has achieved growth rates of around 5 to 6 percent per annum in recent years, her overall record on macroeconomic stability, save for the crisis years of the late eighties, is superior to that of most other developing countries. And judged by he criterion of the stability of policies she has displayed a relatively high degree of political stability. It is, however, India’s trade and FDI regimes which are seen as major impediments to increased inflows of FDI.

4. HISTORY OF REFORMS IN INDIA –

Two distinct phases can be identified in India’s foreign trade and investment regimes- the pre 1991 phase and the post 1991 phase

The Pre 1991 Phase

which stretches over four decades, was marked by extensive regulation of trade and investment. The cumbersome and complex nature of the regulatory framework during these years , Thespecification of sectors in which both foreign financial and technical participationwere allowed, those in which only technical collaboration was permitted, and those in which neither technical or financial participation was allowed reflect the desire to restrict foreign ownership and control to sectors of the economy in which its contribution was deemed to be essential. Restrictions on ownership of equity by foreign firms in cases where projects involved substantial inputs of foreign exchange or were export oriented, also reflect the desire to limit foreign control, but at the same time take advantage of FDIs foreign exchange earning potential where necessary and possible. The Foreign Exchange Regulation Act (FERA) of 1973 was Prime Minister Indira Gandhi's response to the economic crisis that bedevilled most years of her premiership.

The Post 1991 Phase

Relaxation of controls over FDI constituted a significant plank of the wide ranging economic reforms introduced in 1991 (Table 3) The three main elements of the reform were the abolition of the licensing requirements governing domestic investment, reduction in tariffs on imports and relaxation of controls over FDI. The principal changes in the foreign investment regime included automatic approval of FDI up to 51 percent of equity ownership by foreign firms in a group of 34
technology intensive industries, a case by case by consideration of applications for foreign equity ownership up to 75 percent in nine sectors, mostly relating to infrastructure, and the streamlining of procedures relating to approval of investment applications in general. Relaxation of controls over the extent of foreign ownership of equity signals a major departure from the earlier regime, although foreign ownership of equity over and above 50 per cent was subject to the requirement that the investors should balance all outgoings of foreign exchange on account of their operations with export earnings over a seven year period. The reform package as a whole heralded a departure from the earlier dirigiste regime. And FDI flows appear to have responded to the new initiatives; annual average inflows increased from around $384 million during the late eighties to around $ 3 billion during the late nineties.

5. POLICY CHANGES IN INDIA FOR FOREIGN INVESTMENTS –

1. Industrial Policy

The Government’s liberalization and economic reforms programme aims at rapid and substantial
economic growth, and integration with the global economy in a harmonized manner. The industrial policy reforms have reduced the industrial licensing requirements, removed restrictions on investment and expansion, and facilitated easy access to foreign technology and foreign direct investment.

Areas where changes were made are –

• Industrial Licensing
• Industrial Entrepreneurs Memorandum
• Location Policy
• Policy Relating to Small Scale Undertakings

2. Foreign Direct Investment

Foreign Direct Investment (FDI) is now recognized as an important driver of growth in the country. Government is , therefore, making all efforts to attract and facilitate FDI and investment from Non resident (NRIs) including Overseas Corporate Bodies (OCBs), that are predominantly owned by
them, to complement and supplement domestic investment. To make the investment in India attractive, investment and returns on them are freely repatriable, except where the approval subject to specific conditions such as lock -in period on original investment, dividend cap, foreign exchange neutrality, etc. as per the notified sectoral policy. The condition of dividend balancing that was applicable to FDI in 22 specified consumer goods industries stands withdrawn for dividends declared after 14th July 2000, the date on which Press Note No. 7 of 2000 series was issued.

Foreign direct investment is freely allowed in all sectors including the services sector, except a few sectors where the existing and notified sectoral policy does not permit FDI beyond a ceiling. FDI for virtually all items/activities can be brought in through the Automatic Route under powers delegated to the Reserve Bank of India (RBI), and for the remaining items/activities through government approval. Government approvals are accorded on the recommendation of the Foreign Investment Promotion Board (FIPB).

1.Automatic Route

• New Ventures
• Existing Companies

2. Government Approval

• Issue and Valuation of Shares in case of existing companies
• Foreign Investment in the Small Scale Sector
• Foreign Investment Policy for Trading Activities
• Other Modes of Foreign Direct Investments
• Preference Shares

3. Foreign Technology Agreements

With a view to injecting the desired level of technological dynamism in Indian industry and for promoting an industrial environment where the acquisition of technological capability receives priority, foreign technology induction is encouraged both through FDI and through foreign technology collaboration agreements. Foreign technology collaborations are permitted either through the automatic route under delegated powers exercised by the RBI, or by the Government. However, cases involving industrial licenses/small scale reserved items do not qualify for automatic approval and would require consideration and approval by the Government. Automatic route for technology collaboration would also not be available to those who have, or had any previous technology transfer/trade-mark agreement in the same or allied field in India.Further, automatic approval for EOU/EHTP/STP units is governed by provisions

4. 100% Export Oriented Units/ Export Processing Zones/ Special Economic Zones

1a 100 per cent Export Oriented Units (EOUs) and units in the Export Processing Zones
(EPZs)/Special Economic Zones (SEZs), enjoy a package of incentives and facilities, which include duty free imports of all types of capital goods, raw material, and consumables in addition
to tax holidays against export. 100% FDI is permitted under automatic route for setting up of industrial park/industrial model town/special economic zone in the country. To encourage investment in this sector, 100% income tax exemption for 10 years within a block of 15 years is also granted for the industrial parks set up during the period 1.4.1977 to 31.3.2006”.

5. Automatic Approval

The Development Commissioners (DCs) of Export Processing Zones (EPZs) /Free Trade Zones (FTZS) )/Special Economic Zones(SEZs) accord automatic approval to projects where Activity proposed does not attract compulsory licensing or falls in the services sector except IT enabled services

• Location is in conformity with the prescribed parameters;
• Units undertake to achieve exports and value addition norms as prescribed in the Export and Import Policy in force;
• Unit is amenable to bonding by customs authorities; and
• Unit has projected the minimum export turnover, as specified in the Handbook of

Procedures for Export and Import.

All proposals for FDI/NRI/OCB investments in EOU/EPZ units qualify for approval through automatic route subject to sectoral norms. Proposals not covered under the automatic route would be considered and approved by FIPB. [For procedure for automatic approval, refer to para 10.1 & 10.5]. Conversion of existing Domestic Tariff Area (DTA) units into EOU is also permitted under automatic route, if the DTA unit satisfies the parameters mentioned above and there is no outstanding export obligation under any other Export Oriented scheme of the Government of
India.

FDI upto100% is allowed through the automatic route for all manufacturing activities inSpecial Economic Zones (SEZs), except for the following activities

• Arms and ammunition, explosives and allied items of defence equipments, defence aircraft and warships;
• Atomic substances;
• Narcotics and psychotropic substances and hazardous chemicals;
• Distillation and brewing of alcoholic drinks; and
• Cigarettes/cigars and manufactured tobacco substitutes.
• For services, norms as notified, would be applicable

Government Approval

All proposals which do not meet any or all of the parameters for automatic approval will be considered and approved by the Board of Approval of EOU/EPZ/SEZ set up in the Department of
Commerce.

6. ADVANTAGES FOR FOREIGN DIRECT INVESTORS IN INDIA

India had been a much closed economy for a very long time till 1991. Since then India has gradually started to liberalize its markets for foreign investors. Since then the foreign players has entered the India market. This has been very active since past 5 – 8 years. India has been wowing the foreign players in one and many ways.

In recognition of the important role of Foreign Direct Investment (FDI) in the accelerated economic growth of the country, Government of India initiated a slew of economic and financial reforms in 1991. India is now ushering in the second generation reforms aimed at further and faster integration of Indian economy with the global economy. As a result of the various policy initiatives taken, India has been rapidly changing from a restrictive regime to a liberal one, and FDI is encouraged in almost all the economic activities under the automatic route.

Over the years, FDI inflow in the country is increasing. However, India has tremendous potential for absorbing greater flow of FDI in the coming years. Serious efforts are being made to attract greater inflow of FDI in the country by taking several actions both on policy and implementation front. The advantages / prospects for investing in India are noted as below.

• Stable democratic governance throughout 55 years of independence.
• Large market of a middle class of 300-350 million people with increasing purchasing power as reflected by a sustained growth in sales of consumer durables in recent years.
• Access to regional international markets through membership of regional cooperation frameworks such as SAARC, Indian Ocean Rim countries (IOC-ARC), and dialogue partnerships with EU and ASEAN. India also has Memoranda of Understanding / Cooperation partnerships with most African and Latin American regional groupings.
• Foreign investment is welcome in almost all sectors barring those of strategic concern like atomic energy, railways and sensitive defence production.
• Thrust on technology, innovation and knowledge based industries and services.
• Well developed R&D infrastructure and technical and marketing services.
• Large resources of untapped natural wealth.
• Promising future in the burgeoning information technology and biotechnology industries.
• Developed banking system, commercial banking network of over 63,000 branches, supported by a number of international banks, insurance and financial institutions.
• Vibrant capital market comprising 23 stock exchanges with over 9,000 listed companies.
• Developing as one of the largest cost-competitive technical workforce nation.
• Conducive foreign investment environment that provides freedom of entry and exit, investment, location, choice of technology, import and export.
• From April 2000 Special Economic Zones (SEZ) are set up in India with a view to provide an internationally competitive and hassle free environment for exports. Business units may be set up in SEZ for manufacture of goods and rendering of services. All the import/export operations of the SEZ units will be on self-certification basis. The policy provides for setting up of SEZ's in the public, private, joint sector or by State Governments. In simple terms the Special Economic Zones (SEZs) provide virtual offshore operation facilities and advantages of a free trade area.
• Corporate Tax exemptions for a period of 5 years across all sectors.
• Import Duty exemption for EOU’s
• Tax Holidays are given as sops for investing by certain states

To promote FDI further many initiatives has been taken up by Government of India like setting up

Secretariat For Industrial Assistance for entrepreneurial assistance, investor facilitation, receiving and processing all applications which require Government approval, conveying Government decisions on applications filed, assisting entrepreneurs and investors in setting up projects, (including liaison with other organisations and State Governments) and in monitoring implementation of projects.

Foreign Investment Promotion Board to consider and recommend Foreign Direct Investment (FDI) proposals, which do not come under the automatic route.

Foreign Investment Implementation Authority to assist the foreign investors in getting necessary approvals and thereby facilitating quick translation of Foreign Direct Investment (FDI) approvals into implementation. Fast Track Committees have been set up in 30 Ministries/Departments for regular review of FDI mega projects (with proposed investment of Rs.1 billion and above), and resolution of any difficulties in consultation with the concerned Ministries/State Governments. Unresolved issues are brought before FIIA.

Foreign Investment Promotion Council for making the policy framework investor-friendly and transparent. Promotional measures are also taken to attract Foreign Direct Investment into the country. The basic function of the Council is to identify specific sectors/projects within the country that require Foreign Direct Investment and target specific regions/countries of the world for its mobilisation.

These are few and many more initiatives are taken by Government to make investment in India hassle free, lucrative and attractive. These are few of many advantages foreign investors enjoy when they decide to invest in India.

7. ADVANTAGE TO INDIA

• Growth in Exports - India's exports have grown much faster than GDP over the past few decades. For example, its exports have grown over 11% per annum while growth in GDP is about 5% during 1970-98 periods. Exports have grown even faster since 1945-95. Several factors appear to have contributed to this phenomenon including foreign direct investment (FDI) which has been rising consistently especially from the early 1990s. By 1997 India became the ninth largest recipient of such investment among the developing economies (World Bank, 1998:20).

• Economic Policy reforms have played a critical role in the performance of the Indian economy since 1991. Among other things, the reforms have involved opening up the economy, making it more competitive, getting the Government out of the huge morass of regulation, empowering the States to take more responsibility for economic management and thereby creating a kind of competition among them for foreign investment.

• FDI has brought access to modern technologies (technology transfer) and export markets. FDI has also had a far more visible impact as it has involved setting up a production base i.e. factories, power plants, networks, that have generated direct employment. Further there has also been a (forced) multiplier effect on the back of FDI because of further domestic investment in downstream and upstream projects. Eg. Hyundai, Pepsi, Coke, IBM, Nokia, GE, LG, Samsung and the list is endless.

• One idea is that multinational enterprises possess superior production technology and management techniques, some of which are captured by local firms when multinationals locate in a particular economy. A related source of spillovers is forward and backward linkages between multinational and host-economy firms (Rodriguez-Clare, 1996), which may result from multinationals providing inputs at lower cost to local downstream buyers or by their increasing demand for inputs produced by local upstream suppliers.

• The indirect benefits to the Indian market include alignment of local Indian practices to international standards in trading, risk management, new instruments and equity research thus facilitating the markets to become more deep, liquid and efficient in feeding new information into prices resulting in a better allocation of capital to globally competitive sectors of the economy.

• While these portfolio flows can technically reverse at any time, given that the surfeit of international capital chases growth, as long as India follows sensible economic policies, this risk is not as high as it is frequently made out to be.

• The Indian experience over the last decade and a half – despite economic slowdowns, war, droughts, floods, political uncertainties and a nuclear test bears testimony to this.

8. DISADVANTAGES TO INDIA

There is hardly a facet of the Indian psyche that the concept of ‘foreign’ has not permeated. This term, connoting modernization, international brands and acquisitions by MNCs in popular imagination, has acquired renewed significance after the reforms initiated by the Indian Government in 1991. Contrary to the grand narrative of ‘opening of flood gates idea’ of 1991, what took place was a natural process of changes in policies of investment in certain sub sections of the Indian economy.

• Some of the key disadvantages of the FI/FDI into India have been -

1. Crowding out of Domestic Industries

FDI crowds out domestic entrepreneurship hence it is usually required of the investor to ensure a minimum level of local content, export commitment and technology transfer as also dividend balancing, forex neutrality and compulsory listing/dilution in the local market Eg – Walmart’s entry into the Indian market Vs the interests of the large Indian Retailers such as the Future Group, RPG etc.

2. Increasing gap between rich and poor - Foreign investors are exploiting workers in poor countries and initiating a "race to the bottom" in environmental and labor standards. The experience comes from countries like Singapore, China, Chile and Ireland which demonstrate how foreign direct investment (FDI) - with its transfer of technical and organizational innovations and best practices stimulate rapid growth in incomes for all members of society.

When international flows of capital falter there's evidence that the poor in developing countries suffer the most. The extent to which foreign investment can help or harm the poor largely depends upon what our governments and firms choose to do. Many multinational companies voluntarily adopt environmental, social, and governance practices designed precisely to guard against abuse of the environment and the workforce when they invest in developing countries.

But governments in developing countries like India should facilitate and encourage the transfer of this social and environmental practice and maximize the benefits from FDI. If India is keen to ensure FDI is truly pro-poor should follow the following points

Ø Clear the way for free entry and exit in domestic markets by creating competition in product and labor markets and incentives to upgrade productivity and to prevent exploitation of consumers and workers.

Ø Promote education, worker training, and infrastructure to increase domestic capacity to absorb and diffuse good new practices introduced by foreign investors.

Ø Create a policy framework that encourages the adoption of appropriate social and environmental standards in corporate practices.

9. CONCLUSION

We think that Foreign Investment in India has a mutual advantage for both.India has the potential and the environment to grow. For the first time in 15 years, all 3 global ratings agencies — S&P, Moody’s and Fitch — have placed India in the ‘investment grade’. The decision marks a dramatic reversal of the situation India faced in 1991 when it was downgraded by S&P to below investment grade after the Balance of Payment crisis.

A different view on foreign direct investment (FDI)

Governments with over-optimistic expectations from foreign direct investment should be aware that it does not necessarily increase employment and can have negative effects on a fragile economy.

ONE of the myths that appears to be indestructible, despite growing evidence to the contrary, is that of the generally positive and desirable nature of foreign direct investment (FDI). It is certainly seen as being preferable to other forms of foreign capital inflow, such as commercial borrowing and portfolio investment. Furthermore, it is considered to be eminently advantageous in its own terms, and something to be actively sought by governments of developing countries. In fact, access to more FDI is now touted as one of the major benefits of the recent economic globalization, which is supposed to outweigh its many negative effects.In India, this perception has, if anything intensified in recent times.

Of course, one can quarrel with the Finance Minister's (false) notion that tax concessions will work to attract more FDI into a stagnating economy. But the more fundamental mistake is to assume that it is necessary to attract FDI in whatever form into the economy, and that this justifies tax and other concessions.

How little we actually know about even the extent of FDI, and especially stocks of FDI, in different countries? It emerges that official data - including those produced by the International Monetary Fund (IMF) and the World Bank - almost certainly underestimate to a substantial extent, the true value of inward FDI stocks and their absolute rate of increase. Far from trying to improve this state of affairs, the Fund and the Bank have promoted the liberalization of foreign investment regimes, which actually tends to reduce the availability of data and even the possibility of collecting it.

This matters not only because it is useful for a host country to know the exact stocks of inward FDI, but because inadequate assessment of their extent may lead to policy misjudgment and failure to anticipate potential crises.The lack of information on the extent of external liabilities contributed to the external debt crisis of the 1980s, and a similar process may be under way with respect to private investment today. Moreover, since FDI is not unambiguously positive, such lack of knowledge of the extent of inward FDI stocks can even be dangerous in other ways.

Consider, for example, the foreign exchange effects of FDI, which are often simplistically assumed to be positive. In actual fact, the foreign exchange effects are much more negative than what emerges from an idealised view of FDI.The positive effects arise only where new productive capacity is created in the export sector, or in very strongly import-substituting sectors. If FDI takes the form of purchase of existing capacity, even in the export sector it will have a negative foreign exchange effect even if export production goes up, unless the productivity of capital increases enough to offset the other increased foreign exchange costs. At lower levels of import substitution, the effects of "greenfield" FDI on new capacity are much more ambiguous, and may be negative.

Its misleading to assume that FDI necessarily contributes to increased employment. In fact, the employment effect will depend on a whole range of variables, including the balance between greenfield FDI and the purchase of existing assets; the labour intensity of new productive capacities or new organizational techniques; the extent to which FDI-based production substitutes for existing production and their relative labour intensities, and so on. In general, therefore, it is not the case that FDI creates much more net employment unless it is really very large in scale and heavily involved in greenfield activities, and even in such cases it need not be more employment-intensive.

Large-scale flows of FDI also have effects on other domestic economic policies. To begin with, reliance on such flows imposes severe constraints on domestic government policy because of the fear of withdrawal, and of course the potential impact of disinvestment increases as the FDI stock grows. Further, FDI is embodied in the presence of multinational corporations (MNCs) which tend to be large and powerful lobbies in the matter of domestic policies.

The very competition to attract more FDI by governments with over-optimistic expectations regarding such investment, means that all sorts of concessions are offered, which may turn out to be very expensive for the economy in the medium or long term. FDI promotion tends to focus heavily on the demand side, in terms of requirements imposed on host countries which involve changing their own policies in order to make themselves more attractive. Such unilateral concessions are increasingly sought to be entrenched through international agreements.

Much of the over-optimism surrounding foreign investment stems from a tendency to look at the host country in isolation from the developing world as a whole. But in fact there are strong negative spillover effects on other developing countries, which may outweigh whatever limited gains actually do accrue to the host country.

The 1990s boom in FDI to developing countries has the elements of a temporary surge similar to those affecting the market for equity (or portfolio) investment. While deregulation of foreign investment across the developing world has played a role, this has probably been less significant than the large-scale privatization programs, which have been a major source of both FDI and portfolio investment, and the debt-equity conversions, which were especially common in Latin America. Further, some flight capital may re-enter the country as FDI - some estimates suggest that this has been significant, for example, in China.

The globalization of production can be seen as a finite conversion process, albeit one which is more prolonged and complex. But it is important to note that all these features make FDI, along with portfolio investment, strongly pro-cyclical in nature.

FDI can contribute to the underlying fragility of an economy and make it more susceptible to balance of payments crises. First, as rapidly growing stocks of inward FDI generate similarly growing profits that form part of the foreign exchange outflow. Secondly, when FDI fuels an increase in imports, such as capital goods for investment projects and other such payments. Thirdly, because current foreign exchange costs of MNCs typically exceed the foreign exchange they tend to earn through exports of import substitution. Fourthly, through the role played by foreign affiliates, including those involved in retailing, in changing patterns of consumption through advertising and brand promotion.

FDI can contribute to large current account deficits, which tend to precede financial crises. They can also add to both the economic shocks preceding crises and to the process of contagion. Examples are of a number of East Asian economies and of Mexico prior to their respective financial crises. He does not mention Argentina, whose major crisis broke after this book was published, but it provides an even more classic example of his argument.

The "fire-sale" of domestic productive assets to foreign companies, which often accompanies attempts to come out of such financial crisis, may initially limit the reduction of FDI to the affected countries, as indeed happened in South Korea. But this occurs at a high long-term cost, in terms of the build-up of more FDI stock and further adverse balance of payments effects.

Once again, the case of Argentina over the past two decades provides a stark, if telling, example - indeed, it is almost as if this script were written for Argentina, in terms of the pattern of sale of public assets to foreign multinational companies in the early 1990s, followed by very adverse balance of payments effects which contributed in turn to the external debt build-up, which then precipitated the most recent crisis.

Conclusion

This more pessimistic - and more realistic - view of the impact of FDI provides a very different angle on the substantial and rapidly increasing stocks of inward FDI in a number of developing countries. Far from being a source of celebration, it may in fact be, as, "an accident waiting to happen". The latest round of crises in emerging markets has perversely operated to strengthen both the positive attitude to FDI and efforts to promote it. But in the new climate, in which developing country markets are seen as riskier and international investors are becoming more risk-averse, efforts to attract more FDI will involve even more concessions on the terms of such investment. The result will be to accelerate the build-up of liabilities without a commensurate effect on the now seriously limited capacity of national economies to bear them.

In fact, such a crisis appears to be almost inevitable, since any serious efforts to prevent it would require both a change in attitudes to foreign capital and a change in political structures. Only when governments represent the interests of their populations and both their business communities, and have (international) political influence proportional to the populations they represent, can we realistically expect to achieve an international financial and economic system which will genuinely serve the interests of people, and not of transnational companies.

Until then, it looks as if the world will have to brace itself for the next round of financial crises, this time probably emanating from the balance of payments problems caused by the current adulation of FDI. And we in India will have to bear with further concessions to multinational investment that may not be in our long-term interest, even if such investment does choose to come into the country.

Coffin for WTO? International Business- Part 2

End of the road for WTO?

It will be appropriate to foresee that WTO and the present form of DOHA development forum has failed and will go to extinction unless something dramatic happens in 2007

The goal of the Doha talks

The expectation of the Doha talks was that all forms of export subsidies would end by 2013. Trade distorting domestic support would be chopped by at least 60% and tariffs on farm products would be halved by 2013. This seems unlikely to happen because of the present standoff.

Standoff

Trade ministers from 60 of the 149 World Trade Organization member states talked in Geneva for three days pm July 2006 but failed to agree on a blueprint. The conference collapsed two days ahead of its scheduled close, preceded by a walkout by Indian Commerce Minister Kamal Nath in protest against the talks' futility.
The breakdown was hardly unexpected, as it was clear that few members were ready to relax the rigid position they had held for the past two years. While WTO opponents used the collapse to endorse the view that globalization was in crisis again, others said any hopes for an agreement at this "mini-ministerial" conference on reducing farm subsidies and import tariffs for agriculture and industrial products as a part of the Doha round on multilateral trade, were overly optimistic anyway.
A primary focus and stumbling block of the Doha talks are agriculture (read farm subsidies particularly in rich nations) and market access (Read Lesser Industrial tariff and services in developing countries). Supporters of free trade argue that farm tariffs and subsidies in rich countries hit poor nations unfairly because agriculture is a much larger part of the economies of poor nations. EU-US combines inflexible attitude towards cutting domestic support to its farmers and cutting down the export subsidies have stalled negotiations in 2003 (cancum), 2004 (Hongkong). In Geneva (2006) the developing countries les by India, China and Brazil argued that Industrial tariffs couldn’t be brought down to reasonable levels until there is a visible progress on the agriculture issue. The developing countries under the umbrella of G20 understand that the Uruguay talks only marginally benefits them.

Minefeild

While the US refused to reduce farm subsidies to the levels demanded by the developing countries like India, Brazil and China (members of the so-called G20), the EU stance also was an obstacle: it offered just a 50% cut in its agriculture tariffs instead of 64% suggested by the US. On other hand, India and Brazil, which represented the developing countries in the negotiations, were upset because the US, instead of talking about reducing subsidies, actually wanted to increase them while at the same time insisting that developing countries open their markets to industrial products.

Present Scenario as on End of 2006

In July 2006,the talks were dissolved, and may take months or possibly years to restart. Talks on the Doha Development Agenda were put into deep freeze. One of the key reasons talks were down to crunch time is that the US president's "fast track" trade negotiating power runs out in 2007. With it unlikely Congress will vote to extend fast track, any Doha agreement will have a hard time making it through Congress. (MarketWatch)
WTO Director General Pascal Lamy called negotiations to a halt because too many countries refused to compromise on their offers. The aims of the Doha Development Agenda negotiations according to him were to liberalize trade rules and make them more fair, to give developing countries a bigger slice of the global trade pie. The indefinite suspension of the talks means trade rules will remain as they are. Most analysts agree that there is no point in resuming talks until two key election dates have passed - the American congressional elections in November 2006 and the French presidential elections in May 2007.

Let us analyze the various stakeholders of the standoff.

United States

The US as such plays a double game by playing with the farmers as well as with the WTO against subsidies. The industrial lobby is fighting for WTO approval, so that they can penetrate into the developing markets like India , Brazil and China. At the same time they are not ready to stop the subsidies to the farmers.
The congressional elections gave a shot on Pres Bush and the last thing Bush is expected to do is upset US hugely powerful farm lobby citing the presidential elections slated for 2008.
The timescale is made more complicated by the impending expiry in July 2007 of fast track authority, the rule under which the US Congress can only approve or scrap trade deals, rather than change their detail.

European Union

EU is pressurizing for more concessions from developing nations like Brazil and India on Industrial tariffs and services. They are not with US to extending subsidiary reductions in the case of agriculture. They are more adamant against reduction of agricultural subsidies. This is the muzzle power they tried to attain after forming the union- being the larger economy comparable to US and sometimes bigger.

Japan

Japan as such has taken a protectionist position in agriculture as well as tariff cap. Developed countries often give a dig on Japan for the position citing dumping.

G 20 Nations

During the earlier talks the developing countries could shut the mouth of other developing nations. G-20 comprising India, Brazil, South Africa, China, Pakistan and other countries was formed on August 20, 2003, in response to the joint US-EU proposals on farm negotiation before the Cancun Ministerial. Brazil and Argentina have offensive interests in agriculture and advocate trade liberalization through reduction in tariff barriers, while India, Pakistan and China have defensive interests in agriculture.

India and Brazil emerging as power brokers

The group proposed a middle ground formula for tariff reduction that was widely accepted as a basis for further negotiation. On export competition, it proposed a 5-year deadline for eliminating all subsidies. The G20 comprises Argentina, Bolivia, Brazil, Chile, China, Cuba, Egypt, India, Indonesia, Mexico, Nigeria, Pakistan, Paraguay, Philippines, South Africa, Tanzania, Thailand, Venezuela and Zimbabwe. It took a lot of lobbying before and during Hong Kong, with both governments putting their reputation as leaders of the developing world on the line, but they succeeded in getting everybody, though not without some grumbling, to assent to a bad deal. In the lead-up of the Hong Kong ministerial, Brazil and India's new role as power brokers between the developed and developing world was affirmed with the creation of a new informal grouping known as the "New Quad". This formation, which included the EU, US, Brazil, and India, played the decisive role in setting the agenda and the direction of the negotiations.

Developing countries sinister moves

During the Cancun Ministerial, the bullying and arm-twisting tactics of the EU and the US seriously backfired when, in the face of intense pressure, developing countries formed alliances, such as the G20, G90 and G33, to defend their trading interests. Unwilling to accept this shift in power dynamics, developed countries, such as the US, adopted a ‘divide and rule’ response, with a series of aggressive attacks, designed to undermine the new alliances and pick off countries.
Attempts to break G20 by ‘divide and rule’
the G20 membership continued after Cancun with most extreme pressure being exerted on those countries aiming to negotiate FTAs with the US. Guatemala, Peru, Ecuador, Colombia and Costs Rica all left the G20 in the weeks following Cancun in response to threats that their trading arrangements with the US would be jeopardized if they continued as members. Developed countries has started a set of bilateral trade deals, handpicking developing countries so that the developing countries go against their leadership, particularly against India and Brazil.

Bilateral pacts to tame G-20

As the WTO talks are getting into a never ending loop, Developing countries US has already signed 10 bilateral pacts, including that with Australia, Columbia and Oman. Treaties with South Korea, Taiwan and Malaysia are planned on 2007.EU also has got grant plans to press ahead with aggressive bilateral deals irrespective of the outcome of Doha talks , and adopt a “WTO Plus” strategy thereby building a layer up the level of liberalization achieved at the WTO. France intended to focus its bilateral efforts on certain countries where there was strong demand, such as countries in the Association of Southeast Asian Nations (ASEAN) which includes Thailand, Vietnam, Indonesia and Malaysia.They also tries to target the Gulf and the Mediterranean basin in a push towards bilateral trade deals following the collapse of global free trade talks The countries are picked one after the other and are forced into more concessions than what they must have normally got in the WTO framework. The idea is to weaken G20 , particularly India and Brazil. The weakened G20 can be dealt more easily so that the developed countries get more concessions during the next round of talks.

Fight back of Developing countries

What can developing countries do at the scenario? Fight the developed countries in their own game. India is working on a comprehensive economic cooperation agreement with Mauritius, Malaysia and Indonesia and a preferential trade agreement with South Africa and Chile. A free trade pack with Japan is on the way for next year. All other developing countries are thinking in that line. End result? Premature Death of WTO like GATT of course.

Coffin for WTO?

World Trade will survive the multi lateralism or not is an open question which only time can tell. Once the WTO comes apart or the talk fails, most countries have bilateralism to fall back on. Even if the Doha talks continues the delivery will be very late and after all the deadlines have been missed.

Bibliography:

CNN - mainstream news mediaBBC - mainstream news mediaThe Economist - mainstream news media
U.S. Proposal for Global Agricultural Trade Reform
Outlook business weekly
For more information on the Doha round:
A Washington Post article summarizes the current situation.Information on the G8 and G20 groups of nations.The World Trade Organization home page, and statistics on all member nations.
Different Images of same story line .
Different level of protests occured round the world after WTO. Lots of discussion happened on prons and cons of Free trade. I would like to reserve my thoughts to later.

International business- Intro

International trade is the exchange of goods and services across international boundaries or territories. In most countries, it represents a significant share of GDP. Increasing international trade is the primary meaning of "globalization".

International trade is also a branch of macro economics, which, together with international finance, forms the larger branch of international economics.

International trade theory

Several different models have been proposed to predict patterns of trade and to analyze the effects of trade policies such as tariffs.

Ricardian model

The Ricardian model focuses on comparative advantage and is perhaps the most important concept in international trade theory. In a Ricardian model, countries specialize in producing what they produce best. Unlike other models, the Ricardian framework predicts that countries will fully specialize instead of producing a broad array of goods. Also, the Ricardian model does not directly consider factor endowments, such as the relative amounts of labor and capital within a country.

Heckscher-Ohlin model

The Heckscher-Ohlin model was produced as an alternative to the Ricardian model of basic comparative advantage. Despite its greater complexity it did not prove much more accurate in its predictions. However from a theoretical point of view it did provide an elegant solution by incorporating the neoclassical price mechanism into international trade theory.

The theory argues that the pattern of international trade is determined by differences in factor endowments. It predicts that countries will export those goods that make intensive use of locally abundant factors and will import goods that make intensive use of factors that are locally scarce.

Specific Factors

In this model, labour mobility between industries is possible while capital is immobile between industries in the short-run. The specific factors name refers to the given that in the short-run specific factors of production, such as physical capital, are not easily transferable between industries. The theory suggests that if there is an increase in the price of a good, the owners of the factor of production specific to that good will profit in real terms. Additionally, owners of opposing specific factors of production (i.e. labour and capital) are likely to have opposing agendas when lobbying for controls over immigration of labour. Conversely, both owners of capital and labour profit in real terms from an increase in the capital endowment. This model is ideal for particular industries. This model is ideal for understanding income distribution but awkward for discussing the pattern of trade.

Gravity model

The Gravity model of trade presents a more empirical analysis of trading patterns rather than the more theoretical models discussed above. The gravity model, in its basic form, predicts trade based on the distance between countries and the interaction of the countries' economic sizes. The model mimics the Newtonian law of gravity which also considers distance and physical size between two objects. The model has been proven to be empirically strong through econometric analysis. Other factors such as income level, diplomatic relationships between countries, and trade policies are also included in expanded versions of the model.

Law of comparative advantage

Countries have different endowments of factors of production. They differ in raw materials, labor, economics, capital and priority, which are mostly or relatively immobile between countries. The ability to supply goods differs between countries. We will distinguish between absolute advantage and comparative advantage.

Absolute advantage

When one country produce a good which less resources than another country, it is said to have an absolute advantage on that good. Production can be maximized by the specializing county and then trading with the other country will gain maximum for both of them

Comparative advantage

Provided opportunity costs of various costs of various goods different in two countries, both of then can gain from mutual trade if they specialize in producing and exporting those goods that have relatively low opportunity costs compared with the other country.

The basic argument for free trade is based on the economic theory of comparative advantage: each region should concentrate on what it can produce most cheaply and efficiently and should exchange its products for those it is less able to produce.

Companies have a comparative advantage in those goods that can be produced at a lower opportunity cost than in other countries. If companies are to gain from trade, they should export those goods in which they have a comparative advantage and import those goods in which they have a comparative disadvantage.

Gains of trade

• Decreasing costs
• Difference in demand
• Increased competition
• Non-economic advantages

Restricting trade

Arguments on restricting trade

• The infant industry argument
• Reduced reliance on goods, which have little dynamic potential
• To prevent dumping and unfair trade practice
• To prevent the establishment of a foreign based monopoly
• To spread the risk of fluctuating market
• To reduce the influence of trade on consumer tastes
• To import the trade of harmful goods

Methods of restricting trade

• Tariffs and customs duties
• Quotas
• Exchange controls
• Import licensing
• Embargoes
• Export taxes
• Subsidies
• Admistrative barriers
• Procurement policies

Regulation of international trade

Traditionally trade was regulated through bilateral treaties between two nations. For centuries under the belief in Mercantilism most nations had high tariffs and many restrictions on international trade.

Mercantilism is an economic theory that holds that the prosperity of a nation depends upon its supply of capital, and that the global volume of trade is "unchangeable." Capital, represented by bullion (gold or silver) held by the state, is best increased through a positive balance of trade with other nations (exports over imports). Mercantilism suggests that the ruling government should advance these goals by playing a protectionist role in the economy, by encouraging exports and discouraging imports, especially through the use of tariffs.

Free trade

After World War II, strong sentiment developed throughout the world against protection and high tariffs and in favor of freer trade. The results were new organizations and agreements on international trade such as the General Agreement on Tariffs and Trade (1948), the Benelux Economic Union (1948), the European Economic Community (Common Market, 1957), the European Free Trade Association (1959), Mercosur (the Southern Cone Common Market, 1991), and the World Trade Organization (1995).

In the 19th century, especially in Britain, a belief in free trade became paramount and this view has dominated thinking among western nations for most of the time since then. free trade is an idealized market model, often stated as a political objective, in which trade of goods and services between countries flows unhindered by government-imposed tariff and non-tariff barriers. Intellectually, this arrangement is supported by microeconomic analysis and nearly all economists, who argue that the benefit of trade is a net gain to both trading partners. It is opposed by anti-globalization and some labour campaigners due to what they see are many tendencies for abuse by wealthier states.

The term is given to economic policies, as well as political parties that support increases in such trade.

Free trade is usually most strongly supported by the most economically powerful nations in the world, though they often engage in selective protectionism for those industries which are politically important domestically, such as the protective tariffs applied to agriculture and textiles by the United States and Europe. The Netherlands and the United Kingdom were both strong advocates of free trade when they were economically dominant, today the United States, the United Kingdom, Australia and Japan are its greatest proponents. However, many other countries (such as India, China and Russia) are increasingly becoming advocates of free trade as they become more economically powerful themselves. As tariff levels fall there is also an increasing willingness to negotiate non tariff measures, including foreign direct investment, procurement and trade facilitation. The latter looks at the transaction cost associated with meeting trade and customs procedures.

Traditionally agricultural interests are usually in favour of free trade while manufacturing sectors often support protectionism. This has changed somewhat in recent years, however. In fact, agricultural lobbies, particularly in the United States, Europe and Japan, are chiefly responsible for particular rules in the major international trade treaties which allow for more protectionist measures in agriculture than for most other goods and services.

In the years since the Second World War multilateral treaties like the GATT and World Trade Organization have attempted to create a globally regulated trade structure.

GATT

The General Agreement on Tariffs and Trade (typically abbreviated GATT) was originally created by the Bretton Woods Conference as part of a larger plan for economic recovery after World War II. The GATT's main purpose was to reduce barriers to international trade. This was achieved through the reduction of tariff barriers, quantitative restrictions and subsidies on trade through a series of different agreements. The GATT was an agreement, not an organization. Originally, the GATT was supposed to become a full international organization like the World Bank or IMF called the International Trade Organization. However, the agreement was not ratified, so the GATT remained simply an agreement. The functions of the GATT have been replaced by the World Trade Organization which was established through the final round of negotiations in the early 1990s.

The history of the GATT can be divided into three phases: the first, from 1947 until the Torquay round, largely concerned which commodities would be covered by the agreement and freezing existing tariff levels. A second phase, encompassing three rounds, from 1959 to 1979, focused on reducing tariffs. The third phase, consisting only of the Uruguay Round from 1986 to 1994, extended the agreement fully to new areas such as intellectual property, services, capital, and agriculture. Out of this round the WTO was born.

WTO

In the early 1990s the nations of the European Union (the successor organization to the Common Market) undertook to remove all barriers to the free movement of trade and employment across their mutual borders

The WTO discussions should follow these fundamental principles of trading.

1. A trading system should be free of discrimination in the sense that one country cannot privilege a particular trading partner above others within the system, nor can it discriminate against foreign products and services.

2. A trading system should tend toward more freedom, that is, toward fewer trade barriers (tariffs and non-tariff barriers).

3. A trading system should be predictable, with foreign companies and governments reassured that trade barriers will not be raised arbitrarily and that markets will remain open.

4. A trading system should tend toward greater competition.

5. A trading system should be more accommodating for less developed countries, giving them more time to adjust, greater flexibility, and more privileges.

WTO governing rules

· Non-discrimination

· Reciprocity

· Prohibitions of quotas

· Fair competition

· Binding tariffs

Unlike the GATT ,the WTO has the power to impose santionson countries breaking trade agreements. Provision for appeals is there, if the disputes between member countries cannot be taken care by WTO in an amikable way

The Uruguay Round.

Trade talks started in September 1986, in Punta del Este, Uruguay. They eventually accepted a negotiating agenda that covered virtually every outstanding trade policy issue. The talks were going to extend the trading system into several new areas, notably trade in services and intellectual property, and to reform trade in the sensitive sectors of agriculture and textiles. All the original GATT articles were up for review. It was the biggest negotiating mandate on trade ever agreed, and the ministers gave themselves four years to complete it.

Two years later, in December 1988, ministers met again in Montreal, Canada, for what was supposed to be an assessment of progress at the round’s half-way point. The purpose was to clarify the agenda for the remaining two years, but the talks ended in a deadlock that was not resolved until officials met more quietly in Geneva the following April.

Despite the difficulty, during the Montreal meeting, ministers did agree a package of early results. These included some concessions on market access for tropical products — aimed at assisting developing countries — as well as a streamlined dispute settlement system, and the Trade Policy Review Mechanism which provided for the first comprehensive, systematic and regular reviews of national trade policies and practices of GATT members. The round was supposed to end when ministers met once more in Brussels, in December 1990. But they disagreed on how to reform agricultural trade and decided to extend the talks. The Uruguay Round entered its bleakest period.

On 15 April 1994, the deal was signed by ministers from most of the 123 participating governments at a meeting in Marrakesh, Morocco. Pitfalls were talked about and were incorporated into the Doha Development Agenda in late 2001.

DOHA Development agenda

The rebuilding process of trhe WTO began in Doha ,Quatar in November 2001. The meeting between the 142 members of WTO continues with the decision to launch a new round of WTO trade talks ,to be called the ‘Doha Development agenda’

The Doha negotiations are designed to increase the liberalisation of trade. However incorporated negotiations already underway on agriculture and services. Agriculture and services were the only areas where negotiations on further trade liberalization had been mandated in the Uruguay Round WTO Agreements (see Agreement on Agriculture: General Issues).

The Doha Ministerial Declaration sets out the basic mandate for the negotiations. With over three quarters of WTO members identifying themselves as developing countries, the Doha Declaration gives developing country issues a high priority in the negotiations.

The main objectives for agriculture found in the Doha Declaration are for "substantial improvements in market access; reductions of, with a view to phasing out, all forms of export subsidies; and substantial reductions in trade distorting domestic support." Members also agreed to "take note of the non-trade concerns reflected in the negotiating proposals submitted by members and confirm that non-trade concerns will be taken into account in the negotiations as provided for in the Agreement on Agriculture." Most countries accept that agriculture has functions other than producing food and fiber-non-trade concerns-such as food security, environmental protection, structural adjustment, rural development, poverty alleviation, and animal welfare. Non-trade concerns have not received much attention in the Doha negotiations, as countries have concentrated on negotiating cuts in tariffs, domestic support, and export subsidies, while providing for the special and differential needs of developing countries.

In addition to the Doha Ministerial Declaration, two other key Doha documents track progress in agricultural negotiations:

• The General Council Decision of August 1, 2004—also called the "July Package"—provides a framework for "modalities," broad outlines or formulas for reducing import barriers, export subsidies, and domestic support in the final agreement in agriculture.
• The Hong Kong Ministerial Declaration of December 2005 includes preliminary agreements on several issues in the agricultural negotiations. In the area of market access, this includes progress on establishing ad valorem tariff equivalents on which cuts will be based; adopting four tariff bands that would subject higher tariffs to larger cuts; accepting the criteria to select certain products ("Special Products") for reduced tariff cuts by developing countries; and agreement by developed countries to extend duty- and quota-free market access for most products originating from LDCs. The Declaration also documents the agreement to end export subsidies in agriculture by 2013.

For information on the status of the negotiations and other details, see WTO's Doha Development Agenda: Negotiations, Implementation and Development.

WTO Doha Round: The Agricultural standoff

On July 24, 2006, the WTO's Director General announced the indefinite suspension of further negotiations in the Doha Development Agenda or Doha Round of multilateral trade negotiations. The principal cause of the suspension was that a
core group of WTO member countries -- the United States, the European Union (EU), Brazil, India, Australia, and Japan -- known as the G-6 had reached an impasse over specific methods to achieve the broad aims of the round for agricultural trade:
substantial reductions in trade-distorting domestic subsidies, elimination of export subsidies, and substantially increased market access for agricultural products.

Reference:

Wikipedia

Agriculture and the WTO - meeting series - ODI 2005

WTO Official site