Allowing FDI in multi-brand retail....not such a good idea right now

I have been a huge supporter of laissez fair economics and like most readers of this blog, am a capitalist at heart. I have always believed that market forces are the best determinants of investment decisions and that the government must stay out of business itself. Today’s papers have a story that the government is considering allowing FDI into multi-brand retailing. Till now, it’s not been allowed. FDI to the extent of 51% is allowed in single-brand retail stores – hence we see a fair number of MNC brand shops now. I decided to do some research to come to the facts of this case.

The first point to note is that the debate is not so much about allowing FDI.....as much as it is about organized retailing itself. Organized retail means stores that are registered with the sales tax and other authorities. Even without any FDI in retail, the growth of organized retail can cause havoc in the employment sector. It doesn’t matter who owns the large format stores – domestic biggies or MNCs – the impact is the same. So most of the points in this post discuss the impact of organized retail rather than focus on FDI in retail.

There is no denying that allowing FDI into retail has advantages. First and foremost is that the shopping experience becomes better. Shopping at a Big Bazaar is much more pleasant than shopping at a local kirana store. We can “touch and feel” different products.....look at smaller brands (with less advertising firepower)......read the fine print.....evaluate the consumer offers.....and then decide what to buy. As a result, we make better choices. Secondly, the quality of the products in organized stores is better. Organized retailers can be held accountable for the goods they sell (bad goods can be returned back)....thus ensuring that the quality of goods they sell is better. Thirdly, prices tend to drop as retailers buy directly (in many cases) from the producers and cut out the large margins of wholesalers and distributors in the process. In today’s high inflation environment, the government is looking at this as the key reason for allowing FDI.

Most of us well-off people urban people stop reading the rest of the story. We conclude at this point that organized retail is good and that FDI should be allowed. If however, we dug deeper, we would know the problems that would come with a higher level of organized retail. The first major problem with organized retail is that it cuts back on employment. It is estimated that if just one large Walmart-like store opened in each of our million-plus towns....then as many as 4 lac people would lose their jobs. If organized retail became 20% of the total retail market (it is only 2% right now), then as many as 8 million people would lose their jobs. Now, I used to be a skeptic of these numbers till recently. I used to think that these were bandied around by the Leftists who wanted to keep out FDI at any cost. But when I dug deeper, I realized that these numbers were indeed true. Today, as many as 40 million people are employed in small retail shops across the country.....most of them would be rendered jobless if organized retail penetrated deeper.

Why is retail so important from an employment perspective? Because for the unemployed, it is the default sector of employment. For rural people, the default sector is agriculture. For urban people, it is retail. Those who cannot get jobs anywhere often end up starting a small kirana shop of their own. The shop itself may be unviable, but at least it keeps the person busy. As much as 14% of our employment comes from the retail sector; second only to agriculture.

Why are there so few employment opportunities in our country? The reason is that the manufacturing sector hasn’t grown as much as it should have. And even where it has grown, it has grown without employing enough people. It’s sad really.....India’s largest private sector company, Mukesh Ambani’s Reliance Industries.....which has a turnover of some Rs 2.5 lac crores.....employs only about 1,50,000 people. Since most manufacturing is in the private sector, and competition is fierce, employment is usually kept fairly lean. It’s because the manufacturing sector doesn’t employ more people that the unorganized retail sector has grown so big.

If more organized retail is to be allowed, then we must be prepared for higher levels of job losses. If we have to avoid social unrest, then we must expand the manufacturing sector in a very sizeable manner. Hence manufacturing growth MUST precede growth of more organized retail. We must allow liberal doses of FDI in manufacturing first....and set goals for it for employment generation. Manufacturing currently contributes only 25% to the GDP. That figure is ok for the developed world which outsources much of its manufacturing to the developing countries. But for a country like ours, manufacturing has to be the keystone of our economy. We sometimes feel proud that 55% of our GDP comes from the Services sector.....but we often overlook the reality that this number is probably more reflective of our poor manufacturing sector than a strong Services sector.

One argument presented by the supporters of organized retail is that we should be focused on the benefits the population of 1.1 billion people would reap from organized retail. And not worry about the fortunes of the much smaller segment of retailers (some 40-50 million people). But this is a wrong logic. The 50 million retailers probably support some 250 million people. What would happen to them?

The big trick the government has played here is that it has kept the discussion focused on the subject of FDI in retail. By allowing big domestic retailers to come about, it has anyways caused harm to employment. More importantly, it has kept the debate away from its own failure in developing a more aggressive manufacturing policy. How is it any different really whether a Kishore Biyani or Mukesh Ambani set up large format stores and cause unemployment or a Walmart and a Correfour doing so? The end result is the exact same. The issue is not about FDI. The issue is about organized retail. And about the poor size of the manufacturing sector.

I am a big supporter of growth economics. So I am not suggesting that organized retail itself be curtailed. As a country progresses, its retail sector has to modernize too. When we travel to the more developed world.....even to our neighbors in South East Asia.....we are impressed by the retail trade there. We also have no option but to modernize our retail. Hence we have to allow organized retail to grow. What I would like to focus attention on thus is the manufacturing sector. How do we get more investments into this so that large scale employment can be created for our teeming millions? That’s the real issue in the organized retail debate. We need 20 years of big ticket investments in manufacturing.....before opening up FDI in retail.

The real truth is that we are likely to take the decision to allow FDI in multi-brand retail for the wrong reasons. We will take the excuse of high inflation to justify the decision. We will present it as a way to protect the consumer knowing fully well of the problems this decision will create. And we will keep skirting the real issue.....that we need to first create employment in manufacturing. I fear that like many other policies, this one also will cause more harm than do good.