India and Wal-Mart: Democracy at a crossroads

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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.

Farmers, who comprise 60% of India’s workforce, could be one of the biggest beneficiaries of Wal-Mart and other large retail chains entering India. Currently, farmers depend on the traders at the local warehouses to sell their produce. Adding an additional competitor, particularly one that will value quality and will have the ability to pay more in the absence of middlemen, will help farmers get better deals.

While farmers get only a fraction of what their produce sells for on the market, consumers end up paying unnecessarily high prices and have limited choice because of the middleman’s cut and the fact that 40% of India’s fruits and vegetables are lost each year to wastage. Retailers like Wal-Mart will cut out middlemen and create modern cold storage systems and supply chains for produce that will help check India’s double-digit inflation.

Unlike goods sold at hand carts or small unregulated shops (kiranas), goods sold at Wal-Mart can actually be monitored by the government. That means that the more goods that are sold at places like Wal-Mart, the more revenue the government will be able to collect. This additional government revenue can be used to re-train the owners and employees of kiranas for more gainful and productive employment. In fact, India’s commerce and industry minister, Anand Sharma, expects fresh investment to generate 10 million new jobs over three years alone. These jobs will almost certainly be better than those at the kiranas, where laborers are extremely poorly treated.

Opponents must open their minds to the benefits of retail FDI. With the lack of any notable economic reforms in the last two years, a plethora of corruption scandals, slowing manufacturing and agricultural growth, rising interest rates and unbridled inflation, the Indian growth story is losing steam. Wal-Mart offers a great opportunity to get foreign and Indian investors excited again about the country’s economic prospects.

Democracies try to guarantee political rights and civil liberties, but the provision of economic freedoms is often at odds with these goals. Finding solutions to these conflicts is part of the process of becoming a mature, economically and politically free democracy.

Aparna Mathur is a resident scholar and Rohan Poojara is a research assistant at AEI.