“International
Competitiveness, Investment and Finance: A Case Study of India”
Citation: Ganesh-Kumar, A., K. Sen and R.
Vaidya. 2003. International
Competitiveness, Investment and Finance: A Case Study of India. Routledge,
London.
Executive
summary:
International
competitiveness generally refers to the ability of a country to expand its
share in world markets. It is being increasingly recognised both by
academicians and policy-makers that the capacity of a country to increase its
standard of living in the long-term depends on the competitiveness of the
manufacturing sector. At a fundamental level, competitiveness of a country in a
particular commodity depends on the price at which it delivers the commodity in
a foreign market in comparison with the price offered by competing countries
for that commodity in the same market. At an analytical level, the evolution of
overall competitiveness of a country over time depends on both macroeconomic
and microeconomic factors.
The
most important macroeconomic variable influencing international competitiveness
is the real exchange rate. At the micro level, traditional trade theories have
seen competitiveness in terms of factor endowments (labour, capital, natural
resources, etc.) of a country and have argued that unit labour costs are the
key determinant of international competitiveness. New trade and
technology-based theories, on the other hand, have stressed the importance of
non-price factors such investment, technological capability and quality as
being more important than price factors in the ability of an industry or firm
to gain international competitiveness. A thread common to both the traditional
and new trade theories is that all the factors identified as influencing
competitiveness are ‘real’ factors. Both these two sets of theories, and the
empirical literature following these two approaches, ignore important financial
factors that can affect the capacity of a firm to compete internationally. Yet
modern views on finance, originating from the asymmetric information/agency
costs framework, argue that the financial environment could impose constraints
on firms to obtain investment funds and thus, constrain their abilities to make
costly investment decisions required to compete in international markets.
There
have been few empirically grounded country-level studies of the determinants of
international competitiveness that examine the latter both from a macroeconomic
and microeconomic perspective, and within an analytical framework that stresses
financial and real constraints to international competitiveness. In this book
we attempt to fill this gap in both the theoretical and empirical literature on
international competitiveness. From a policy perspective, especially in the
context of a developing country, it is important to study the links between the
real and financial factors in affecting international competitiveness, so that
export promotion policy measures that may already be in place can be
strengthened and made effective.
We
posit the relation between the real factors and the financial factors through
the volume of investments undertaken by a firm. That is, productivity growth,
technological up-gradation, and the capacity to deliver the required quantities
(i.e., the scale of operation) are firm level factors that affect the
ex-factory competitiveness and these are directly influenced by the firm’s
investment decisions. The decision to invest would of course depend on the
firm’s perception of the future returns that the investment would yield.
However, how much is actually invested depends on the availability and the cost
of funds. The latter in turn depends on the institutional setting in the
financial sector and the efficiency of this sector in making funds available at
the right cost to those sectors where the potential for growth is the highest.
A weak institutional setting in the financial sector can raise the cost of
investible funds for a firm, and thus reduce the amount that a firm actually
invests, which in turn would restrict its ability to compete in international
markets. We test our hypothesis empirically using India as a case.
Past
studies that empirically examined international competitiveness have been at an
aggregate level in terms of overall export performance, and / or at the
sectoral level, where export performance of individual sectors were related to
various real factors such as unit labour costs, measures of technology, etc.
There is no study that we are aware of that has also studied the issue of
international competitiveness at the firm level. In this book, we study
international competitiveness at the aggregate level, at the sectoral level and
at the firm level, and thus go beyond the existing literature on this issue. We
test our hypothesised link between investments and exports at both sectoral and
firm levels, and then proceed further to examine the link between financial
factors and firm level investments, thus completing the chain of reasoning.
The
book is organised into the following seven chapters.
1) Competitiveness,
investment and finance: Analytical links
2) The
policy environment in India
3) The
balance of payments and national competitiveness
4) The
determinants of sectoral competitiveness
5) Outward orientation: A firm-level
analysis
6) Finance constraints, persistent
exporting and investment
7) Conclusions and Policy Implications
The main
conclusions emerging from our analysis are as follows:
At an
aggregate level, our estimates of the balance of payments constrained
equilibrium growth model reveals that real exchange rate depreciation, real
growth in remittances and world income growth have a positive effect, the
latter being the strongest, on India’s economic growth suggesting that the
income elasticity of demand for India’s exports may be rising. This rise in the
income elasticity seems to have come about more through a realignment of
India’s export focus towards fast growing / important markets of the world
rather than through greater specialisation in the more rapidly growing
commodities in world trade.
At the
sectoral level, we find that the investment rate has a positive and significant
effect on industry export shares, thus establishing a clear role for the
investment rate in influencing sectoral competitiveness. While unit labour
costs do not seem to influence sectoral competitiveness, decomposing it into
its components – real wage and labour productivity – reveals the negative
effect of the real wage and the positive effect of labour productivity on
sectoral competitiveness. Thus, both price and non-price factors do matter in
determining international competitiveness at the industry level.
Defining
competitiveness at the firm level has been problematic in the literature.
Instead we look at a firm’s outward (export) orientation. Our analysis of a
sample of 672 firms over the period 1992-93 to 1997-98 points to an increasing
outward-orientation of the Indian manufacturing sector, both in terms of the
number of new firms entering the export market, and existing exporters
expanding the proportion of output exported. We also find that exporters differ
significantly from non-exporters, even within the same industry. On an average,
exporters have higher capital stock, output, investment rate, use of imported
capital goods (as a per cent of net fixed assets) and imported raw materials
(as a per cent of sales) than non-exporters. Furthermore, there is clear
evidence of persistence of exporting behaviour, with firms that enter the
export market tending to stay on for several more years.
The
analysis of the determinants of exporting at the firm level brings out the
importance of prior exporting experience as a variable that significantly
increases the probability of a firm exporting in any given period, supporting
the argument that firms face large sunk entry costs in entering the export
market, leading to a high degree of persistence in exporting behaviour. We also
find that large firms, foreign owned firms, and firms in industries where other
firms are exporting, are more likely to be exporters. Finally, investment and
exporting is strongly correlated at the firm-level, as firms that have
exhibited investment bursts in the previous period are more likely to be
exporters in the current period. The latter finding provides
us with a basis for exploring the role of financial factors in influencing
investments and hence export competitiveness at the firm level.
Specifically, we look for the presence of finance constraints on the investment
decisions of firms in our sample, especially the outward oriented firms.
Our
estimates of the investment function at the firm level suggest that the
availability of internal funds constrains firm level investments, and that
persistent exporters face a lower degree of finance constraint than occasional
/ non-exporters. This seems to indicate that suppliers of funds in India use
the firm’s exporting history as a signal of the strength of the firm, and that
persistent exporters are less constrained by the availability of internal funds
than firms which export occasionally or sell only to domestic markets. Further
our attempt at tracing the source of finance constraints shows that the degree
of the ‘finance constraint’ differs significantly across external suppliers of
funds. Our results suggest that investments are most sensitive to borrowings
from Development Finance Institutions (DFIs), while this sensitivity is
remarkably lower with regard to funds from capital markets and commercial
banks.
The
above results also seem to indicate the possible presence of a
“poor-export-performance-trap” operating on occasional / non-exporters. Given
their poor past export performance, they are subject to a higher degree of
finance constraint and hence they are unable to make the necessary investment
in order to become successful exporters.
A theme
that emerges clearly across all these stages of analysis is that heterogeneity matters in the
understanding of international competitiveness. We get a vastly richer
perspective when we attempt to account for heterogeneity at each stage of
analysis. A key implication of our analysis, is that the response of the balance of payments to
adjustments in the exchange rate is far more complex than what neo-classical
models suggest. Our analysis suggests that export supply functions need to take
account of the number and type of firms already exporting, and the perceived
permanence / transitory nature of changes in the exchange rate. Thus, the
response of aggregate or sectoral exports to changes in the exchange rate would
be country and period-specific.
Much of
the focus of export promotion policies in developing countries has been on
expanding the export volumes. Our analysis suggests that there is a need to
distinguish between policies that are aimed at (i) expanding export volumes of
existing exporters, and (ii) promoting the entry of new exporters. Our analysis
has revealed two “structural” barriers that firm wishing to enter export
markets face. One, the presence of significant sunk entry costs (including
costs of gathering information on the demand conditions in foreign markets,
establishing distribution networks, etc.) and two, the operation of a
poor-export-performance-trap arising from the way the financial sector
functions in the presence of informational asymmetries and agency costs. The
policy regime has to recognise the role of investment in determining export
performance and the importance of an efficient financial sector capable of
channelling resources to the more dynamic firms / sectors in the presence of
information asymmetries and agency costs. This implies that reforms that
pertain to the real sector alone (such as industrial deregulation and trade
reforms) may not be sufficient to enhance the country’s competitiveness if
complementary financial sector reforms are not undertaken.