When candidates flip-flop, their poll numbers suffer, but when countries flip-flop, entire economies suffer. This scenario is playing out in India after the government flip-flopped on its decision to allow retail giants such as Wal-Mart to own a majority 51% stake in joint operations with a local partner. Just last week the government gave the go-ahead for this reform. Unfortunately, the victory was short-lived as leftist politicians and even right-winged opposition parties seeking to disrupt regular functioning of the government forced reform-minded Prime Minister Manmohan Singh and the ruling UPA coalition to roll back their decision on Wednesday.
Clearly democracy is not always the panacea it is made out to be. By most measures, India is one of the most democratic countries in the world, with popular elections held every few years and 59 percent of the population voting for their political leaders. However, that very feature makes the government vulnerable to the whims of their political partners and the masses. In a democratic country, the system of political participation and representation of interests of multiple parties puts political constraints on governments. These constraints often prevent governments from pursuing economic reforms that they support, since they have to balance the interests of the majority while pushing ahead with any major reforms.
A recent paper that one of us co-authored and published in the economics journal Applied Economics talks about this very issue. That paper found that democratic countries often receive less foreign direct investment (FDI) inflows than other countries that guarantee economic freedoms but not necessarily political and civil rights. The reason is that investors value countries that guarantee economic freedoms such as personal property protection, the right to move capital in and out of the country and the ability to trade openly in world markets. Most importantly, they value the predictability of doing business. This is tough to achieve in a country like India, where some people still view foreign capital as being antagonistic to the interests of the poor. The process of opening up sectors to foreign investment has therefore been very gradual and successive governments have had to appease the working classes and the farmers in order to move the process forward. Hence, governments obviously face a more complex task in countries where people enjoy the right to be heard. This helps explain to some extent why India ranks a lowly 124 out of 179 in The Heritage Foundation’s and The Wall Street Journal’s 2011 Index of Economic Freedom. India especially lags other nations in the Investment Freedom metric, where it scores an unimpressive 35 out of 100 while the global average is over 50.
FDI in retail would have several economic benefits for Indians. Retail FDI could mean up to $20 billion in annual investments. This would benefit the extremely weak rupee, which has fallen from mid-2007 levels of 39 INR/USD to over 52 INR/USD. India’s central bank has struggled to contain the rupee’s slide due to the flight of foreign funds seeking safety in the current uncertain economic climate. Large investments by retail giants like Wal-Mart, Tesco and Carrefour would help prop up the rupee.