Does Foreign Investment Help an Underdeveloped Country?

Many people, including many Indian economists, believe that for progress India should encourage and facilitate foreign investment in India.

I do not agree, and would like to give my reasons.

The English economist Adam Smith in his well known book ‘ The Wealth of Nations ‘ published in 1776 advocated open markets, and relatively barrier free domestic and international trade. In other words, Smith was against not only constraints on domestic industry, but also against protectionist policies against international competition.

In contrast, the German economist Friedrich List in his book ‘The National System of Political Economy ‘ published in 1841 said that international free trade would result in subjection of the less advanced nations by the more advanced manufacturing and commercial nations. He advocated protection to domestic industries by less industrialized nations ( by high customs duties, quotas for foreign goods entering the domestic market,  etc ).

It may be mentioned that England was the first country in the world to industrialize, which it did in the first half of the 18th century. German industrialization began much later, and at that time German industries were small compared to British industries, so they needed state protection to face the competition of British industries, otherwise German industries could not survive. This protection, List argued, should be in the form of customs duties or quotas on British goods.

A giant can fight another giant. But a child cannot fight a giant. So a child must be protected and nurtured until it, too, becomes a giant.

Those who argue that foreign investments create jobs, overlook the number of jobs it destroys, which may be 10 or more times than what it creates. The British East India Company brought foreign investment into India, and no doubt created some jobs in railways, plantations and some light industries e.g, textiles. But it destroyed the huge handicraft industries which gave employment to tens of millions of Indians, and had made India a prosperous country under the Mughals.

There was huge foreign direct investment, mainly by the Britishers, during British rule, but it left India impoverished, with only 2-3% of the world’s wealth and world foreign trade by 1947, when it was perhaps the richest country in the world under the Mughals, with about 25% of the world’s wealth and world foreign trade.

So FDI means nothing if it does not benefit the Indian masses, but benefits only some foreign multi-national corporations. In fact it may result in loot of India ( as it happened during British rule ), destruction of markets for our own industries, and increase in unemployment in India

List pointed out that when Britain was doing its own industrialization, it was done under heavy protection to its industries ( by high customs duties, etc ). But when they had broadly completed their own industrialization, Britishers started preaching the virtues of free trade to other nations ( so that they would open their markets to British goods ).

List wrote ” Had the English left everything to itself—’Laissez faire, laissez aller’, as the popular economical school ( i.e. Adam Smith’s school ) recommends—the German merchants of the Steelyard would be still carrying on their trade in London, the Belgians would be still manufacturing cloth for the English, and England would have still continued to be sheep-farmers. Indeed, it is more than probable that without her highly protectionist commercial policy England would never have attained such rapid industrial growth “.

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The German authorities followed List’s recommendations, and imposed, particularly under Chancellor Bismarck, high customs duties on British imports, with the result that German industries, which were then small compared to British ones, could get protection from British competition, and could  rapidly grow. Japan, too, did the same after the Meiji Restoration of 1868.  So did USA, and in fact this was one of the causes of the Civil War of 1861-65, the North, which had set up many industries, wanting protection from British industrial imports, while the South, which was largely agrarian, opposed high customs duties, as it depended on large cotton exports to England from its plantations, for which the British could only pay if they could easily sell their industrial products in USA.

Since India is less industrialized as compared to developed countries, in my opinion India too must follow List’s theory. Our industries need protection if they are to grow. For instance, Chinese goods are capturing our markets, and in my opinion heavy customs duties should be imposed on them, or their entry into India should be prohibited altogether.

FDI ( foreign direct investment ), far from being encouraged, should be greatly restricted, and should be allowed only in sectors where it would help our domestic industries grow, e.g. where it would lead to transfer of new technology from foreign companies to Indian ones.

This does not mean we should restore  the licence-permit raj which had strangled our economy for decades. I am against most of internal restraints, and am only referring to free entry of foreign goods and foreign investments into India, which should be greatly restricted, to give protection to our own industries.

At the same time, special help by the state should be given to our new industries and new entrepreneurs , as was done by the Japanese government after the Meiji Restoration, so that they can tide over the difficulties which all new entrants ( start ups ) face. In particular, special help and concessions should be given to small and middle level industries, as these have few reserves and financial back up. Youth starting as entrepreneurs should be given special help, e.g. in the form of loans at low interest, free technical advice, tax holidays for long periods, etc.

Most of the nations which are today industrialized did their industrialization under governments which were friendly to their domestic industries and businesses, and helped promote them. India too should do the same.

Markandey Katju is an Indian jurist and former Supreme Court judge of India who served as chairman for the Press Council of India. He has also worked as Standing Counsel for the Income Tax Department. 

The views expressed in the article are the author’s own and do not represent the editorial policy or views of Global Village Space.