To start with, I want to reaffirm that India needs economic reform, and lots of it. Reforms should strengthen governance institutions as well as the working of markets. An increased role for markets and competition will, on the whole, benefit the Indian economy. If reforms are done well, they can promote inclusive growth. With all that clearly stated, I want to question some of the reform rhetoric around FDI in multi-brand retail, and argue for making a different set of reforms a priority if we want to improve the supply chain, whether farm to fork (or fingers, really, for India), or for manufactured goods.
Certainly, Western retailers such as Walmart and Tesco can bring in knowledge that comes with vast experience, as well as large dollops of capital. If we can have McDonald?s in India, bringing in new ideas, high standards of customer service and process efficiencies, why not foreign retailers too? Certainly, it will help to increase competition and innovation in retailing. But some of the arguments being made seem to have shaky foundations.
First, since wholesaling has already been opened up to FDI, why are we not seeing improvements in the supply chain? The greatest inefficiencies, especially in agriculture, are before the wholesale stage. Why have foreign entrants not made a big difference? It could be that they need scale economies at the retail stage to make it worthwhile to change the supply chain, but I haven?t seen that argument articulated, let alone validated.
Second, is Walmart or Carrefour really going to want to change the agricultural supply chain and thereby benefit farmers? Fresh food is not necessarily a high margin category?grocery store margins in the West are wafer thin. There is more money to be made in packaged foods, and much more in non-food items, especially durable goods. If we are talking about processed foods, why haven?t the big food processors already made significant efficiency improvements in the supply chain? What would Walmart add to their capabilities? If, as I suspect, the real impact will be in non-food items, that may be good for consumers if competition brings down prices, but then all the claims of helping farmers through FDI in multi-brand retail are irrelevant. Again, I am not saying that it is a bad idea, merely that the case has not been properly made: the rhetoric outstrips the reasoning.
Now let me offer an alternative reform. Let?s start with the problem. Farming is inefficient. This has a lot to do with farmers being small: they face problems of liquidity, as well as risk and uncertainty. These problems are particularly severe for farming, given the long production cycles and vagaries of the weather. But they are universal problems of small business. Illiquidity and variability can bring down small businesses much more easily than large ones (unless the latter are like Lehman Brothers or AIG). Before small businesses can grow, they have to survive. Mechanisms to increase liquidity and reduce risk raise their chances.
Markets for providing these services to small businesses are therefore very important. They existed as long ago as 17th century London, laying the groundwork for the development of formal banking. In such markets, small businesses can borrow against, or sometimes sell, illiquid and uncertain assets such as accounts receivable and inventories. The intermediaries who provide these services have the scale that gives them greater liquidity and risk tolerance. They can smooth their returns over time as well as diversify risks.
The market for such services, called factoring services, is in its infancy in India. In December 2011, a bill was passed to regulate such services. It received little fanfare. As is often the case in India, there are elements of over-regulation in the new law. But it provides a clear legal framework for the industry. There is a reasoned debate on how to improve the new law, and reduce transaction costs further. New entrants are coming in. Some are arms of banks; some are partly backed by banks. But potentially factoring can be done by any firm, and often is, through mechanisms such as trade credit. The market needs to grow much more.
So here is my hypothesis. The problem of small business and small farmers in India is lack of financial services that enable them to manage their liquidity and risk efficiently. Now, these services are often provided by firms with market power, who squeeze the small producer (the old interlinked moneylender model). Even in prosperous states like Punjab, small farmers are subject to these pressures. If we want to improve the supply chain, or if we want inclusive growth by promoting small enterprises, why not intervene right at the source of the problem, rather than at the opposite end of the value chain? And why not do it directly? Keep building institutions that relax the financing constraints of small producers. Increase competition in this market to serve those producers. In that case, Walmart can wait.
The author is Professor of Economics, University of California, Santa Cruz
