Governance and Foreign Investment in China, India, and Taiwan: Credibility, Flexibility, and International Business

Chapter 6. The Political Economy of Special Economic Zones in India

132 Chapter 6 The Political Economy of Special Economic Zones in India Just as puzzling as China’s success in attracting FDI under the authoritarian rule, which challenged conventional wisdom, is India’s long-­ delayed growth of FDI under the democratic system. Between 1980 and 2010, India received $200 billion of cumulative FDI inflows, less than one-­fifth of the amount China received, which was $1.1 trillion (UNCTAD 2012).1 Unlike China, which lacked the fundamental institutional attributes to assure international investors of its credibility when it began its economic reforms in the early 1980s, India has a history of democracy and rule of law that provides a sound political and legal environment for foreign investors. Although India’s economic reform started more than a decade later than China’s, a number of scholars have argued that the acceleration of economic growth occurred around 1980, thanks to the shift of government policies from left-­ leaning, anticapitalist rhetoric to a growth-­ oriented, pro-­ business strategy (DeLong 2003; Rodrik and Subramanian 2005; Kohli 2006). The Organization for Economic Cooperation and Development (OECD) attributes India’s recent FDI boom to the economic reform that dismantled the “license raj” and relaxed the restrictions on large-­ scale investment (OECD 2009), but the 1991 reform, as argued by Kohli (2004), did little to lift up the minimal role of FDI in India’s economic growth. Indeed, as late as 2002, India was still considered an underperformer, given its disappointing FDI performance and low potential (UNCTAD 2002). Only in recent years has India made impressive strides in attracting FDI, as its FDI inflows have grown to a mag- The Political Economy of Special Economic Zones in India 133 nitude greater than that of most developing countries (OECD 2009). Survey reports by international organizations and consulting firms have consistently ranked India as one of the most attractive destinations for foreign investors (e.g., A. T. Kearney 2007; UNCTAD 2009). Why did it take more than a decade for India’s economic reform to produce a business environment conducive to FDI? Not only did India’s FDI trajectory occur much later than China’s, but the patterns of FDI inflows were also different. The bulk of FDI inflows in China go to a broad range of manufacturing industries, which accounted for 57 percent of total FDI inflows between 2004 and 2010 (National Bureau of Statistics of China 2005–­ 11). Unlike China, India attracted little FDI in manufacturing industries. The service sector has been the largest recipient of FDI, receiving 21 percent of FDI inflows between 2000 and 2010 (Ministry of Commerce and Industry 2011). A high portion of FDI inflows into China consists of labor-­ intensive export-­ oriented investments, whereas FDI inflows in India were concentrated on sectors that use capital and technology more intensely.2 On average, foreign-­ invested enterprises (FIEs) in China exported 41 percent of their products, whereas foreign firms in India sold 90 percent of their outputs in India’s domestic market between 1998 and 2002.3 Why do these similarly endowed, high-­ growth economies differ so distinctively in the patterns of FDI inflows? This chapter addresses the preceding questions from an institutional perspective , by situating the overarching credibility-­ flexibility framework in the Indian context. I argue that India’s democratic institutions provide essential political assurance to foreign investors but that its market became conducive to FDI only when the government adopted investment policies that were more flexible. Specifically, the initiation of the system-­ changing SEZ policy, despite the straightjacket imposed by the political system, was important in enhancing the flexibility of the government and thus facilitating foreign investment. Introducing effective “single-­ window clearance” and administrative systems into SEZs not only would avoid the political pressure to satisfy a broad range of social expenditure requirements but also would limit state governments’ discretionary intervention. The implementation of the SEZ policy, however, generated contentious political battles that imposed governance barriers on SEZs. Political forces from partners in multiparty coalitions, state governments, and a variety of interest groups wielded effective vetoes over three key areas—­ tax incentives, 134 governance and foreign investment in china, india, and Taiwan land acquisition, and labor regulations—­ and created a great deal of uncertainty in the investment environment. Thus, foreign firms’ investment patterns were shaped by the governmental environment, which could be both collaborative and combative. Foreign firms tend to invest more in capital-­ intensive information technology (IT) and service...