Trade Protectionism: Is there a way out?

The outbreak of global protectionism would cause catastrophic economic hardships across the globe. It would also severely undermine the future viability of WTO and its progress so far.

One of the most feared economic consequences of the global financial crisis of 2008 has been the protectionist juggernaut by governments. As the global economy begins to emerge from the worst economic crisis since the Great Depression, there is a growing concern that rising protectionist spiral could short-circuit the nascent global economic recovery. Despite repeated promises by the global leaders to minimize trade barriers, protectionist measures have been rising. According to a report released by Global Trade Alert (GTA), a trade policy think tank based in Europe, the accumulated number of protective trade measures across the world increased from 85 in July 2009 to 297 as of December 9, 2009. In the second quarter of 2009, though many economies have turned the corner, protectionist pressures have not softened. The GTA report reveals that the protectionist dynamics were worst in the first three quarters of 2009, but protection ism hasn’t yet reached the scale of the 1930s —but water doesn’t have to boil to scald.

To discriminate against foreign producers, protectionist measures like higher tariffs, import quotas, exchange controls, immigration restrictions and export subsidies are being planned by governments around the world to secure their own economic interests. Even the US, the global free-trade champion has imposed 46 separate protectionist measures on goods and services trade with the outside world. The EU implemented 90 and countries like China and India introduced 51 and 29 of such measures. The GTA report says this tendency is particularly worrisome. Global trade flows have already suffered their sharpest drop since the 1930s and trade analysts expect global trade would fall more than 10% this fiscal with both supply and demand hit hard by the recent global financial crisis. The trade volume will decline mainly on account of shrinking economies, lack of trade finances and protectionism measures by governments.

Rising Trade Conflicts

The trade ties between China and the US, generally labeled as the ballast and engine for overall bilateral relations, have witnessed intensive exchanges in 2009 amid soaring trade disputes. In the first three quarters of 2009, the US launched 14 trade remedy investigations against China, involving $5.84 bn, a year-on-year rise of 639%. Political pressure for protectionist measures is increasing not only in the US but also in the European Union. As the trade between these nations simmers, the US federal government recently announced a new $2.8 bn tariff on Chinese steel imports. Other economies are beginning to follow the US lead as well, imposing trade restrictions from antidumping duties to more subtle policies like tougher standards. Critics warn that Obama administration stance could provoke similar moves by other countries that could cut off vital export markets at a time when American manufacturers and service providers need them most. Against this move, China has already launched efforts to restrict imports of American auto parts and poultry products.

In fact, protectionist measures are common for the US government. When it imposed a tariff on steel during the Bush regime, most steel products were affected adversely. While the tariffs are not as broad-based this time, the problems can be intensified due to the considerably weakened position of the US economy. There is no doubt that the trade ties will encounter disputes from time to time during the process of cooperation.

Nevertheless, analysts believe “the interdependency is not poised and China’s excessive dependence on exports and the US excessive dependence on consumption are not sustainable. Whether or not their relations will develop healthily and continuously is of great significance to the economies of the two countries, and even that of the world.” However, Chen Dongxiao, Vice-President, Shanghai Institute for International Studies opines, “It might be a zero-sum game for both China and the US when it comes to specific industrial sectors, however, it is a positive-sum game for their overall economic relations.”

Disorderly Global Growth

By opening the gates to foreign investment and manipulating its currency from rising against the dollar, China’s economic strategy has been remarkably successful over the last two decades. Thus, the dragon hobbled itself to consumers in the industrial world and achieved outstanding growth. Whilst the strategy is still working for China, it is worsening economic security around the globe. As it continues this strategy, other economies have started using their last available weapon, protectionism measures to stop the surge of artificially cheap Chinese goods. This is the reason why trade analysts always quote: “a trade war is easy to start and hard to contain. It could hit everybody’s exports, disrupting growth everywhere.”

The dragon has flooded the globe with exports and has edged out suppliers from other developing nations. Now its economic strategy is doing considerably more harm than in the past. Amid global slowdown, many countries fiscal stimulus efforts have been weakened by inflows of cheap Chinese imports and absorbed some of the money added by government’s stimulus packages. If China continues its present currency policy, trade experts say it will make even more difficult for the global economy to revive. As overstrained governments settle down their fiscal stimulus, many other economies will have to rely on exports as a crucial source of demand while their consumers are reorganizing their personal finances.

Henceforth, if China sticks to its cheap-renminbi manipulation, it is bound to draw a protectionist response from its trade partners. The US government has already imposed exceptional tariffs on Chinese tires and antidumping duties on steel pipes. Indian officials also filed a stack of trade complaints against China. Even the APEC (Asia-Pacific Economic Cooperation) urged the adoption of ‘market-oriented exchange rates’ for Asian currencies, a reference to China’s manipulation. Trade experts opine “A trade war with China would be disastrous and bound to escalate around the world. Restraint is needed. But we fear no one is going to feel restrained if China doesn’t change its strategy.”

Wider Economic Implications

The outbreak of global protectionism would cause catastrophic economic hardships across the globe. It would also severely undermine the future viability of WTO and its progress so far. Sergio Marchi, Senior Fellow, International Centre for Trade and Sustainable Development (ICTSD) warns that “Protectionism would severely disrupt crucial trade traffic flow, and create chaos at that intersection. Economically painful for countries, big and small alike, but they would also deliver a severe body blow to the very values embodied by the WTO.” In a globalized world, there is no haven to hide from global storms. In times of economic crisis, countries seek to protect their own industries and jobs. The political mood in the US is uncongenial to free trade, and Europe faces similar pressures. However, economists suggest that “Whatever their downsides, economic integration and free markets remain the best strategies for prosperity and growth, for developed and developing economies.”

Therefore, governments must take steps to stabilize their economies, protect their citizens and prepare their countries for the recovery. Lee Hsien Loong, Prime Minister, Singapore, advocates, “after having witnessed a spectacular failure of untrammeled free markets, we must not swing to the other extreme. Governments and regulators clearly need to improve how they set the rules, supervise financial institutions, and monitor risks to the system as a whole. But human nature being what it is, we can’t prevent crises from happening.

We can only hope to reduce their frequency, and the damage they cause.” According to the World Trade Organization and other international bodies, the world has not relapsed into 1930s style beggar-thy-neighbor protectionism. So far, countries have largely avoided self-defeating protectionist measures. However, trade analysts suggest that “they must stay the course as unemployment stays high, and muster the political will to revive the Doha Round of world trade negotiations. The US must exercise leadership, and other major players must be prepared to close the last gaps and seal a deal.”

Whether it is China or the US, protectionist measures will simply make everyone worse off, leaving consumers with fewer choices and higher prices. Therefore, governments need to swallow their pride and drop the tariffs. If the free-trade champion doesn’t lead on free trade, no one will. Daniel J Ikenson, Associate Director, Center for Trade Policy Studies, the Cato Institute, foresees: “Despite the global economic contraction and the occasional protectionist indulgence, there is reason to be hopeful that retrogressive policies will be marginal, short-lived, and ultimately rejected.” During the Great Depression, there were no proven stopgaps to prevent the pandemic of spiraling protectionism that erupted and exacerbated the global recession. But today the world has solid institutions and incentives to help steer policy-makers away from the abyss. More than eight decades of trade relaxation rules have brought about greater confidence and stability, and thus more investment, trade, and economic growth. Daniel further adds, “today, the commercial  and political appeal of protectionism is considerably diminished because most countries have established domestic constituencies that depend on a trade and investment environment that is open in both directions.”

Lessons to learn

The fight against trade protectionism is far from over going by record levels of unemployment in some developed countries which, in turn, generate more and more concerns. In future, the global economy prospects will depend on governments effective and harmonized steps to address deeper, more difficult problems. Challenging days lie ahead for the international trading system as some Nobel Prize-winning economists in the US are resorting to arguments of protectionism against China as a recipe to cure the jobless rate in their country. They predict, “it may be too early to conclude that the US will be in a trade war with China. Yet, serious US acts of trade protectionism against Chinese products coupled with the departure from the very broad consensus among economists for free trade.” The lesson to be learnt for the policymakers is that it is the interest of every country to keep global trade flowing smoothly. A healthy trade environment can help revive the world economy, if not, history could repeat itself. The fact that international trade system sailed smoothly in 2009 indicates that the world leaders have learned the lessons of the past to prevent trade protectionism from further worsening the global financial crisis. The recently concluded G-20 summit, the participants insisted that they understood “the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty.” Notwithstanding, the later initiatives taken by them indicate that during the times of slowdown, it is often difficult to stick to the greater good.

N Janardhan Rao, Lead Economist.

India as Knowledge Superpower

India should aim to have entrepreneurial skills, efficient social organization, and education that encourage creativity and curiosity, as the building blocks to develop itself into a knowledge superpower.

Little knowledge is indeed a dangerous thing. More so in today’s information age where knowledge plays an integral part in the development of an economy. Today, no economy can remain competitive without applying knowledge and, currently, the most technologically advanced economies are truly knowledge-based. Lester C Thurow, noted MIT economist, writes in his book Building Wealth: The New Rules for Individuals, Companies and Nations, “Knowledge is the new basis for wealth. This has never before been true. In the past, when capitalists mentioned about their wealth, they were talking about their ownership of plant and equipment or natural resources. In the future when capitalists talk about their wealth, they will be talking about their control of knowledge.”

Therefore, in the coming years, it is just knowledge, knowledge and more knowledge that will rule the world! Tangible or physical resources are passé and knowledge is the “in thing”. India too has realized this, and is gradually and successfully transforming into a knowledge-based economy.

Taking a cue from other knowledge-based economies that are progressing and doing well globally, India is surely catching up with the trend and gradually transforming into a knowledge superpower. The country is well on its way to harnessing novel as well as existing knowledge to improve the productivity in agriculture, industry, and services for the overall economic and social welfare.

The availability of skilled, English-speaking knowledge workers, a well-functioning democracy, and its large domestic market are providing the country with the much required advantage to evolve into a knowledge economy. The consistent and remarkable development of Information and Communications Technology (ICT), a free-market economy, and an efficient private sector are the strengths the country can rely upon. However, Indian culture has always valued knowledge very highly, and these cultural values too are responsible for driving the country towards being a knowledge economy.

Towards the Knowledge-based Economy

The world is witnessing the dawn of the information age in which knowledge is the standard of measurement. More than 50% of the Gross Domestic Product (GDP) in the major OECD economies now depends on the production and distribution of knowledge. Countries like the US, Canada, Australia, Ireland, and Singapore have embraced the knowledge economy and are experiencing strong GDP growth as a result. But what exactly do we mean by a knowledge economy?

According to the United Kingdom Department of Trade and Industry, “A knowledge-driven economy is one in which the generation and exploitation of knowledge play the predominant part in the creation of wealth”. All in all, knowledge economy is based on human ingenuity and skill, and an exclusive dedication to innovation through research and development.

The Knowledge-Based Economy (KBE) emerges from two crucial forces: the rise in knowledge intensity of economic activities and the increasing globalization  of economic affairs. While the former is being driven by combined forces of Information Technology (IT) revolution and the changing face of technology, the latter is being driven by national deregulation and by IT-related communications revolution. Unlike the traditional factors of production, the source of wealth is not finite. The knowledge economy produces goods and services effectively at lower costs to a greater number of people. Research indicates that a KBE comprises four main elements. These four structural forces driving the economic transformation are: revolutionary changes in Information and Communications Technology (ICT), rapid scientific and technological advancement, global competition, and shifting consumer demand.

India’s inherent strengths are the pillars of support for its transformation into a knowledge economy. The key ingredients include a critical mass of skilled, English-speaking knowledge workers, and of course a well-functioning political system. Rapid advances in important knowledge-based sectors like ICT, pharma, R&D, health care and nanotechnology are fast turning India into a force to reckon with. According to R A Mashelkar, director general, Council of Scientific and Industrial Research of India, “India is already gaining international repute for its innovations in areas ranging from pharmaceuticals to software.

Information Technology will achieve even more as it improves the efficiency of public R&D, increases private R&D, and encourages greater university-industry linkages. It is leveraging traditional knowledge with modern science and exploiting public-private partnerships to support grass roots innovations, which can improve the quality of life for the poor. An example is the Computer-based Functional Literacy Program, initiated by Tata Group to overcome illiteracy through innovative use of IT”.

The time is very favorable for India to make its transition to a knowledge economy. However, it is not new to the idea of knowledge being central to the development and progress of a country. A 2005 World Bank report titled “India and the Knowledge Economy – Leveraging Strengths and Opportunities” by Carl Dahlman and Anuja Utz says, “The notion of a new knowledge economy is not new or foreign to India. India’s past achievements in science, philosophy, mathematics, and astronomy reinforce the notion that the country has, for millennia, been a leading knowledge society”.

The country has always valued knowledge highly and it is this culture that is driving the country towards a knowledge base. John Daly, a US-based freelance consultant working on issues of technology and science for developing countries opines, “I see India’s growth in knowledge-intensive fields continuing. And that growth is yielding substantial long-term economic and social benefits to India.” India’s consistent economic progress on the back of its services-led growth has the world mesmerized.

Commenting on India’s almost magical growth and progress Thomas L Friedman, author of The World is Flat, said, “You’re seeing an explosion of 10 years of pent-up aspirations. If you want to know what India feels like today, it’s very simple. Pull out a champagne bottle, shake it for an hour, and take the cork off. You don’t want to get in the way of that cork.” This quote perhaps sums up the kind of perception that India is currently viewed with.

Sectors Already Thriving

India is doing exceptionally well and is showing great promise in the realms of pharmaceuticals, IT, nanotechnology, biotechnology, R&D, and animation. John Daly opines, “Clearly, software and ICT-enabled services are important industrial drivers. I expect to see areas such as pharmaceuticals increasingly important, and India benefit economically from nanotechnology-based industries.” Indianpharmaceutical companies are successfully discovering new chemical entities for diseases.

In the domain of nanotechnology, the country has 154 research centers, mainly focusing on new drug delivery systems. India has also tied up with the US in the area of nanotechnology, which is anticipated to produce new vistas. In biotechnology, India takes the credit for discovering an alternative fuel—Jatropha, which is changing the oil dependency pattern of modern civilization. India is also making swift progress in the area of stem cell research. Three major Indian institutions are finding the cure for glaucoma, eye ulcers and chemical incidences through the application of stem cell research.

Information Technology and offshoring services have been major contributors to India’s economic growth in the recent past. According to McKinsey, share of IT Software and Services Industry in India’s GDP is expected to reach 7% of GDP in 2008 from 4.1% of GDP during 2004-05. R&D, too, has gained significant momentum and is attracting multinationals to invest in the country.

A host of international IT bigwigs made a beeline to India recently, and announced huge investments in R&D. Foreign IT giants like Intel, Cisco Systems, Microsoft have announced billion dollar investments in India and a large chunk of these amounts is assigned to the R&D sector. The increasing importance given to the R&D activities by domestic companies across various sectors is also attracting foreign players to invest in India. For instance, according to a study of 25 domestic drug companies, the R&D expenditure of these companies went up sharply by 42% to Rs.1814.65 cr during the fiscal year 2004-05 from Rs.1278.08 cr in the previous year.

Leveraging the Opportunities

India needs to seize the opportunities provided by the knowledge economy, and according to experts, innovation is the key to development and progress. A significant part of India’s innovation system is the dispersion of modern and more efficient technologies in all sectors of the economy. As John Daly avers, “I don’t think India will progress as much as it should without a policy environment that encourages investment and innovation. And I think it is important to strengthen institutions including India’s participation in international markets, legal institutions, governance institutions, intellectual property rights institutions, etc.”

India has a vast pool of highly educated and talented people. However, they relatively represent a small fraction of the total population. The country has a majority of the labor working in sectors like agriculture, informal industry, and informal service activities. To increase the overall productivity of the country, workers should be moved from these low productivity and subsistence activities to more contemporary sectors and to new knowledge-based activities, which are more productive and will also help in bridging the economical divide.

John Daly opines, “In the sense of using improved knowledge as a driving force behind all aspects of Indian development, I think the development of the knowledge economy is central to the overall development. The experience in Western nations is that improved technology and improved organization drive the productivity improvement that in turn drives long-term growth. Thus, modern knowledge institutions are critical to improving agricultural productivity, providing good health services, etc.” Economic success in today’s KBE increasingly depends upon the effective utilization of intellectual capital such as employees’ knowledge, skills, innovative potential, as well as their ability to continuously improve those processes.

Employment in the KBE is characterized by increasing demand for more highly skilled workers, also called “knowledge workers”. In advanced economies such as the US, more than 60% of workers are knowledge workers. Knowledge workers are termed as “symbolic analysts”—people who manipulate symbols rather than machines. Anuja Utz, co-author of the report says, “To create a sustained cadre of knowledge workers, India needs to make its education system more demand driven to meet the emerging needs of the economy and to keep its highly qualified people in the country.” She further adds, “This means raising the quality of all higher education institutions, not just a few world-class ones, such as the Indian Institutes of Technology.”

The ICT sector in India is progressing swiftly and is responsible for dramatically changing the face of economic and social activities, and the acquisition, creation, dissemination and use of knowledge. The World Bank report titled “India and the Knowledge Economy” says, “India’s IT companies are moving up the value chain, and India is now undertaking new and innovative work, such as the management for clients of IT-related business processes”. India should leverage this opportunity as it has already proved its prowess in IT and IT-enabled services.

Challenges to Overcome

India is currently facing a slew of problems, and manpower shortage is one of them. It needs to maintain a constant flow of skilled manpower to sustain the high rate of growth in various sectors. According to the Nasscom-McKinsey Report 2005, India will need a 2.3 million strong IT and BPO workforce by 2010 to sustain its share in the global market. If the quality of education is not upgraded immediately, a shortfall of nearly 0.5 million qualified employees is estimated, of which 70% will be concentrated in the BPO industry alone.

The biotech industry, which is worth Rs.4,745 cr and growing at a rate of 37%, is also facing a huge demand-supply gap for experienced technical and marketing professionals. Another high action-packed area, i.e., the retail industry, which accounts for 11% of India’s GDP, is facing a serious talent crunch. Not only is the number of educated unemployed increasing, but also the demand for skilled professionals is growing day by day in the country. India produces around 200,000 scientists, engineers and technicians annually. However, the country fails to derive full economic benefit from this talent base, because of the mismatch between education and the labor market. A growing gap is emerging between the knowledge that they possess and the real practice. The low wages in India lead to brain drain, which is also a major hurdle to a country growing as a knowledge economy. Immediate efforts should be made to advance policy and institutional reforms in scientific and technical education to improve the quality of India’s existing and future talent pool.

Apart from the talent crunch, there are a few more fronts that India needs to work on for a smoother transition to a knowledge-based economy. The country lacks an efficient information infrastructure, which is one of the most important factors for the nurturing of knowledge. India also needs to rev up its efforts to tap the swiftly growing stock of global knowledge through channels such as FDI, technology licensing, importation of capital goods that embody knowledge, and also advanced products, components, and services. When compared to other countries like China, India relatively lags behind in effectively using these resources.

Considering the pace with which knowledge is being globalized, it would be logical to seek knowledge beyond borders. Also, the fact that India has the largest number of illiterates in the world cannot be forgotten. As John Daly concurs, “I would suggest that educational excellence must be spread much more widely if India as a whole is to enter the knowledge economy. It would be very unfortunate if a dual society is institutionalized with an educated elite participating fully in globalization, and an uneducated majority left behind.”

A Knowledgeable Future

Currently, India is undergoing a gradual transition towards a knowledge-based economy. The dramatic increase in the number of global companies outsourcing their knowledge processes to India is also proof enough that India is no longer perceived just as the “back office” of the world. While a majority of India’s population still consists of rural and illiterate people, the scenario gradually seems to be changing. Even in slums of Delhi or Mumbai, children are being educated and becoming aware of IT from a very young age, and this is certainly going to help India in the long run. As C K Prahalad, an Indian-born American and renowned business consultant said, “Every kid here who is walking around is getting trained to be an entrepreneur, to hustle, and to get a little bit more than he or she has.”

However, for the country to have an effectual transformation into a knowledge economy, it needs to act in different policy domains, “deepening, complementing, or reorienting” ongoing reforms to use knowledge efficiently and to sustain development in the long run. India needs to understand that policy reforms of any kind would not yield results overnight. Consistent and collaborative efforts from the government, industry and academia are necessary to make India a knowledge-based society. More and more R&D activities are the need of the hour. Kiran Karnik, former president, NASSCOM, opines, “The future lies in knowledge and technology, for economic strength, poverty eradication and military security.

India’s government and industry must wake up to this reality and invest more in R&D.” The masses and all the stakeholders in the government, private sector and industry need to be made well aware of the plans and the needs to transform India into a knowledge-based economy, because the future lies in “Brain, not brawn”. Success of countries, companies and individuals will directly depend on the knowledge they possess, and how effectively and efficiently they put it to use.

N Janardhan Rao, Lead Economist.

Economics of Indian Agricultural Sector

 

“Agriculture is not a commodity machine but the backbone of the livelihood security system in India, where 70% of the population is in the villages. So, agriculture is not just a question of economics and trade but of dignity and survival. We need to develop a long-term stake in agriculture. This will pay enormous dividends.”

-      Dr. M S Swaminathan, Renowned Agriculture Scientist.

Agriculture in India plays a vital role. It contributes more than a fifth of the country’s Gross Domestic Product (GDP) and generates 60% employment. The country has 170 million hectares of vast arable land and a range of agro-climatic conditions to produce a wide array of primary food crops. To its credit, India is the world’s largest producer of fruits, vegetables, milk, pulses, wheat and rice. The crop production dominates the sector, representing 70% of the total value of agriculture output. Of the total value of crops, fruits, and vegetables account for 32%, rice 15%, and wheat 10%. In the remaining value of total crop production, oil seeds represent 7%, sugar cane 7%, pulses and coarse 4% each and cotton 2%.

Indian, being an agrarian economy, the performance of agriculture is very important not only from the point of view of economic growth but also for the well-being of the majority of the population. There is no economy in the world impacted more by agriculture than India. Given the sector’s importance, the fate of the economy in India is directly linked to the pulse of agriculture. Though the service sector is booming as the engine of economic growth in the recent past, there is no argument over that India is still agrarian economy.

Agriculture has turned the country’s begging-bowl image to self-sufficiency in food grains. However, critics say that it will be difficult for India to sustain its success without a dramatic change in policy. Since independence, achieving food security or self-sufficiency at national level and household has been one of the main focuses of the sector. These policies have cost exchequer immensely. During the last five decades, the food subsidy (the cost of price support and food distribution) has risen sharply and is estimated that it will increase to Rs.270 bn ($5.9 bn) in 2004-05. These policies also indirectly caused lower levels of infrastructure and this attributed to lower rates of productivity improvement. Experts say that food management policies must, therefore, be geared up to meet the daily food needs of the people rather than be confined to creating huge buffer-stocks in the name of food security.

The Challenges

The sector that provides 60% of employment is virtually stagnant and its development has largely been ignored both by the central and the state governments. During 1980s, the sector witnessed 4% annual growth. Since the outset of reforms process, economists say that whatever money was going into the sector it was increasingly in the form of subsidies, but not investment. This resulted in only 2% annual average growth in 1990s. Besides, the sector is facing several internal and external challenges. Internal challenges like farm production, processing industry and marketing have been there for some time. Further, heavy dependence on monsoons, fragmented land-holding, which are sinking with each generation, low level of input usage, poor pre-and post-harvest practices and inadequate marketing infrastructure are some of the well-known weaknesses that lead to low yields and high cost of the farm produce. These are well recognized and need to be tackled on a war footing. The external challenges have emerged in recent past and are threatening to weaken the sector.

The industry chamber, the Federation of Indian Chambers of Commerce and Industry (FICCI) recently highlighted the alarmingly poor infrastructure in agriculture. Accordingly, about 30% of the villages do not have a metal road within a five km radius, 55% don’t have a seed store, over 80% don’t have repair facilities for agricultural implements, 75% don’t possess warehousing facilities and 60% don’t have a market center. These constraints are inducing low productivity and are plaguing the sector. For instance, from 170 million hectares, it produces 600 million tones, whereas the neighboring country, China harvests from 96 million hectares 860 million tones of food grains. Accordingly, its share in global trade in processed foods is not more than 1% of the global processed food trade and only 1.3% of the total fruits and vegetables produced are processed as against 40% for some developing countries and 70% for developed countries. Around 40% of the India’s produce goes waste every year. The quantum of fruits and vegetables wasted in India is equal to the annual consumption of the UK! In value terms, the loss due to wastage of food grains is Rs.50, 000 crores per year, which is six times the annual food subsidy. In the days to come, the sector will face significant challenges and an opportunity to raise food production, going by the population growth, which is projected to rise to 1.5bn by 2030 from 1bn now. Therefore, the country cannot ignore the challenges of food production and productivity. If we continue to treat the sector in the same way, going by the population growth, it is not ruled out that we may have to import food grain once again.

The Remedies

The need of the hour is a foolproof approach to address agriculture-related issues. Experts say if the Indian Government prioritizes the encouragement of massive investment, especially on rural roads, agricultural research and soil conservation, irrigation, then the sector can play a really effective role for the economy. The Indian government has announced some measures in order to put agriculture and rural development in the spotlight. The government must ban the movement of agricultural products between states so as to enable farmers take advantage of the domestic market. Accordingly, the policy of curbing exports of agricultural products should be reconsidered so as to create export market for the sector. According to a study by CII-McKinsey, India can be the largest food factory given the fact that its food production is equal to that of the US and is second only to China.

The Value Addition

The development of agro-based industries including animal husbandry, fisheries, forestry and food processing are very decisive for the sector. Experts feel that it is time we looked at agriculture from the global standpoint. To its credit, the sector is the world’s largest producer of fruits and vegetables and has enormous prospect for business. Currently, only one per cent of its output is processed. Modernizing the food chain is expected to help inspire a food revolution, raising yields and incomes. This will benefit the nation as well as the industry.

However, the food-processing industry is stated to be caught in a vicious cycle of inefficiencies, wastage. The country’s food processing involves only primary processing which accounts for 80% of the value. Overall, 42% of the food industry is in the organized sector and 33% in the small-scale, tiny and cottage sectors. Also, there are inherent inefficiencies of high cost, scale diseconomies and inadequate logistics support. Even with this stage, by 2005, it is expected to grow up to Rs. 4,80,000 crores, of which Rs. 2,25,000 crores would be value- added foods. Going by the potential of food processing, further development of food processing has a multiplying effect. Experts say that if India has to compete globally, then agricultural production and processing must take place at international costs. In other words, efficiencies need to be built into the agricultural production and processing systems. Newer production technologies need to be examined. However, to maintain this growth tempo, the CII-McKinsey study estimates that large investment of Rs. 1,40,000 crores by 2005 in technologies, skills and capital equipment is necessary.

The Need of the Hour

Being an agrarian economy, the development of sector is extremely important for India. The promotion of cold storages, post-harvest technology and the strong food processing industry are the need of the hour. Ashok Gulati, Director, International Food Policy Research Institute, Washington, USA, says, “If Indian agriculture has to be embrace globally competitive, it does not need sops of free power or even cheaper credit. What it desperately needs is investment in rural infrastructure, agriculture R&D, and effective institutions that can promote efficiency by reducing transactions costs and market risks.”

The industry body, Confederation of Indian Industry (CII), articulates that agriculture in 2004 is similar to it was in 1991. It says that the private sector was awaiting policy reforms that would allow it to make much larger investments in the sector. It believes that agriculture reforms and increased private investment must benefit farmers, especially small farmers by greater corporate investment in getting competitive source of finance, competitive markets to sell to; and competitive suppliers of knowledge. To improve the sector further, economists emphasize that enhancement of farm production through substantial investment in agricultural infrastructure is the only effective instrument for eradication of rural poverty. India has to gear up to exports primary commodities, one of the great challenges of the sector. For instance, Guatemala, a small country, earns more from pepper export than India do because of value addition.

To sustain the growth tempo, it is imperative to make the sector both economically rewarding. It is equally important that the economic benefits of food processing and agri-business are taken to the rural areas. This, in turn, would lead to mechanization of farming and processing. Besides, as experts suggest, privatization of agriculture could be the solution to the problems faced by farmers. Their land holding could be merged in a proper manner, though it need not tantamount to cooperative farming. With larger holdings, farmers can make use of advanced technologies in farming apart from making their voices heard. Finally, to sum it up, as Dr. M.S. Swaminathan recommends, “Marketing is the best fertilizer for the farmer. Once the infrastructure is in place, we can definitely usher in another Green Revolution.”

N Janardhan Rao, Lead Economist.

Farmland Investment: Gaining Momentum

Rising demand for food grains in Asia owing to economic boom and growing demand for corn and ethanol worldwide has resulted in renewed interest in Farmland investment. Similar demand is witnessed in the Gulf countries which have benefited from the current Oil boom but are dealing with rising food insecurity. These countries have started scouting for agricultural investments in Afro-Asian region. This renewed interest in farmland is raising hopes of providing a solution to the global food crisis at a time when the global population is increasing and food production is stagnating.

The age of agriculture is back in trend, as the global food crisis is forcing people to take a fresh look at farming. Farmland is undergoing the biggest revival, as the growing demand for food grains and soybeans from Asia and for corn and ethanol worldwide are making food production procedure a very costly affair. The economic boom in the emerging economies is further driving up the prices of commodities to record highs. Over the next decade, China and India are expected to add around 3-5 million middle-class population each year. This total does not include the growing middle-class population in Latin America, the Middle East and Eastern Europe.

Demand for corn to feed livestock climbed 24% during the last decade as personal incomes and animal protein consumption in emerging economies increased considerably. Rice-bowl nations like China, India, Thailand and Indonesia have already curbed rice exports. Food riots are ravaging several Afro-Asian nations, leave alone oil prices.

In fact, the rising food prices are threatening to increase the possibility of adding another 100 million people to the 852 million who are already hungry. Jacques Diouf, Head, Food and Agriculture Organization (FAO), admitted that “food output must rise 50% by 2050 to meet the rising global demand. However, over the past 20 years, we have neglected investment.” According to FAO statistics, the total agriculture development aid to poor nations plummeted by more than half to $3.4 bn in the last two decades. During the same time, agriculture’s contribution towards development shrank from 17% to 3%. Recently, the World Bank has acknowledged that from 1991 to 2006, it allotted only 9% of its total lending to sub-Saharan farmers who depend on agriculture for their livelihood. As a result, many countries got out of the business of seed, fertilizer and grain marketing, and the unprepared private sector with too little access to financing failed to fill the gap. A growing number of economists are now convinced that the poor nations need a healthy farm sector for sustained economic development.

Gaining Global Demand

The Gulf region may be enjoying the current oil-boom, but it is a victim of food scarcity. Global food crisis has put the Middle East and Africa in a fix, as they are forced to choose between growing more crops to feed their ever-increasing population and at the same time conserving their already scant resources of water. In the Middle East, existing water sources are estimated to last for only 30 years, while population is expected to grow more than double the world average. Further, the region is crippled by a dry climate and shortage of agricultural land; as a result, most of the countries import 90% or more of their food grains. Against this, depending on food supplies from outside world is not only perilous but shortsighted, especially in an era of trade restrictions. 

To meet this increasing demand, many sovereign states are resorting to expensive schemes to secure food supplies for their people. Several Persian Gulf nations, including Saudi Arabia, have started scouting for farmland in the fertile Afro-Asian countries. The UAE and Yemen are pursuing deals worth billions of dollars with several private companies in Sudan and Pakistan for cultivating rice, wheat, sugarcane and fruits. Egypt, where a paucity of subsidized bread sparked civil unrest earlier this year, is aiming to grow wheat on two million acres along the border with Sudan.

South Korean and Chinese multinational firms, with help from their governments, are entering in a big way to invest in farmlands in Russia, Burma, Laos, the Philippines and Africa for growing rice, corn, sugarcane, cassava and rubber. According to the Lao Committee for Planning and Investment, China already has become the second largest agriculture investor in Laos and Burma. It is providing seeds, fertilizers, pesticides and farm machinery to the farmers in those nations. China, under pressure to feed its 1.3 billion population, wants to enforce high tariffs on food imports from developed countries. With food grain stocks exhausted and prices at an all-time high, the poor nations too are turning their back on the old ideas and opening doors to investors. This has encouraged businesses and investors to channelize billions of dollars into farmland and food production.

The prudence to foresee mounting demand for food has led to investments in facilities involving food production such as farmlands, fertilizer, grain elevators (buildings for storage and shipment of grains), barges (flat-bottomed boats built mainly for river and canal transport of heavy goods) and ships. Even though the equity markets have not completely come to terms with the enormity of this growing demand, private equity and hedge funds around the world are making huge investments in farmlands.

College endowments, pension funds and real estate fund managers are buying farmland, even as home construction companies are deserting thousands of undeveloped parcels in the US. They are aggressively placing bets on agricultural commodities like corn, wheat and soybeans. Fresh from the sting of the subprime catastrophe and the credit squeeze, banks and investment companies are also beginning to add farms to their more conventional investments. A majority of them believe that although the current surge in food prices is partly due to transitory factors like drought and biofuel subsidies, the demand for food is likely to rise in the long run, which presents a potential investment prospect. In fact, the value of farmland has been increasing at rates greater than the residential market growth over the past decade.

Untapped Potential

According to Agcapita GP Corp, a Canadian farmland investment partnership, in addition to providing a potential hedge against inflation, an investment in farmland provides returns with less volatility (approximately 60% less volatility) than stock and bond market returns. Investment funds have already started pouring in billions of dollars into frontier lands (land that has not yet been cultivated for production) in less developed nations in Eastern Europe, Southern America and Africa for cultivating commodities like wheat, corn and soybeans. Some have bought several ethanol plants and farmland in Canada and adequate storage space in the Midwest to keep millions of bushels of grain.

The UK-based Braemar Group was the first to spot an opportunity in the potential of farmland investment. Europe is under pressure to increase biofuel production, and the farmland close to the northeastern England will be the first source of supply of ethanol.

BlackRock, a company partly-owned by Merrill Lynch, is planning to invest in farmland in sub-Saharan Africa to the English countryside. In 2007, the London branch of BlackRock launched the BlackRock Agriculture Fund, seeking to raise $200 mn to invest in fertilizer production, timberland and biofuels. Presently, it stands at more than $450 mn. Calyx Agro, a group of Louis Dreyfus Commodities, is purchasing vast stretches of farmland in Brazil in a big way with help from large institutional investors like AIG Investments. Emergent Asset Management, a UK-based, award-winning investment management firm, is raising $450 mn to $750 mn to invest in farmland in sub-Saharan Africa. The fund has chosen Africa because of inexpensive land values and accessible labor compared to other agro-based economies. Moreover, Africa’s micro-climates are conducive for cultivating a wide range of crops. These investors are getting positive response from institutional investors like insurance firms and some Sovereign Wealth Funds.

Speculative Investments?

The long-term implications of the sudden surge in farmland investments are not clear. Some conventional players in the farm economy and others who actively involved in agriculture policy believe that the new breed of investors will focus on returns above all else, and are not committed to staying with farming through good times and bad.

The cycle of entering in and out of farmland investment will be very volatile and could become subject to speculative bubbles. Mark Lapolla, Adviser to institutional investors, says, “It is important to ask whether these financial investors want to actually operate the means of production or simply want to have a direct link into the physical supply of commodities and thereby reduce the risk of their speculation.”

However, the proponents of farmland investment dismiss the criticism that the investors will control the supply-demand mechanism artificially by holding back inventory to move prices to their benefit. They argue that the investments will be advantageous to farming community and, finally, to consumers. When food grain prices become volatile, grain elevator operators have to dig deep into their pockets to lock in future prices. It is here the financial investors come to the rescue of grain elevator operators by providing the money they need to endure the unpredictable commodity markets. Maintaining these important services helps bring down costs to the farmers and negates the price increases for crops.

Furthermore, new investments will bring in the latest technology and accelerate the development of infrastructure, and the consumer will benefit because there will be more supply. The investors aim to combine small plots of farmland into more productive assets and modernize grain elevators and fertilizer supply depots, so that they can increase production and reap profits.

A Win-Win Approach

The present surge in farmland investment is a result of skyrocketing commodity prices, increasing demand for ethanol, and the continuous decrease in the area of arable agricultural land globally. Against this backdrop, farmland investment is the best long-term approach to agricultural development, taken up by entrepreneurs who sense opportunities when others see gloom. Some analysts see the potential for significant and lasting benefits to both parties. For instance, even though investment is meant to benefit the investors, foreign investment helps poor nations in Afro-Asian region which lack the resources to make their own agricultural land productive by improving infrastructure and irrigation. If poor nations can lay emphasis on local agriculture by opening thousands of new acres to food grain cultivation, they can save enough money on imports and divert it for economic growth within a short span of time. It is significant to note that these investment funds are using their own money. If they are successful they will realize significant profit, the world supply of food will increase, and in the process food grain prices may stabilize.

  Countries Investing in Farmland Away from Home

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Sovereign State               Have Already Bought/Expressed Interest In

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Abu Dhabi                          Sudan

Bahrain                              Philippines

China                                 Africa and South America (Brazil)

India                                  Paraguay and Uruguay

Libya                                 Ukraine

Saudi Arabia                      Thailand and South Africa

UAE                                  Pakistan, Sudan, Egypt and Yemen

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Source: www.seekingalpha.com

Indian Scenario

Agriculture in India has transformed significantly over the past few decades. However, lack of agri-infrastructural facilities as well as field-level operational flexibility has hampered the agricultural growth story. Even though the government plays an important role in providing essential inputs like fertilizer, water and energy, the importance of the private sector cannot be ignored. Private sector provides additional investments, brings greater efficiencies and ensures superior service to the end consumer at an affordable price. The possibility of joint ventures with international investors and training institutes to provide training to farming community to use latest technology is to be explored. Therefore, there is a need to devise a long-term strategy like integrating the private sector with agriculture, which will avert the vulnerability of the farming community and step up agricultural growth.

If farmers are exposed to market signals, they can become more productive and competitive. In the absence of such an environment, it is vital to have policies targeted to tackle specific issues - such as environmental, animal welfare and other concerns - that are unbiased and more efficient than market interventions. Reliable initiatives and investments are the need of the hour to put farming back on a growth trajectory.

Harriet Friedmann, Professor, University of Toronto, suggests, “Farmland and farmers are a public good and need to be both protected and encouraged through public policies to engage in sustainable food production in tandem with managing natural resources for the whole society, particularly soil, water, energy and carbon sequestration. It follows that speculative pressures to maximize revenues in the short-term deepen existing problems; fundamental changes in land use management are needed instead.” With increased investments in farmland and the resultant increase in food production output, food prices may begin to head southwards in the coming years. Jeff Conrad, President of John Hancock’s Ag Investment Group, which has invested more than $800 mn in farmland, tells investors, “Farmland is not a quick buy and flip type of thing. It takes time to work a return—periods of 7 to 10 years to hold the investment.”

N Janardhan Rao, Lead Economist.

Public-Private Partnership (PPP) – Understanding Various Models

 

A public-private partnership (PPP) is a contractual agreement between the public and the private sectors, whereby the private operator commits to provide public services that have traditionally been supplied or financed by public institutions. The ultimate goal of PPPs is to obtain more “value for money” than traditional public procurement options would deliver. When correctly implemented, PPPs are said to produce reduced life-cycle costs, better risk allocation, faster implementation of public works and services, improved service quality and additional revenue streams.

The core principle of PPPs lies in the risk allocation between the two parties. A well designed PPP redistributes the risk to the party that is best suited to manage it and to do it with the least cost. The PPP models vary from short-term simple management contracts (with or without investment requirements) to long-term and very complex BOT form to divestiture.

Introduction

The significance of Public-Private Partnership (PPP) model has been gaining increased thrust of late as the double whammy of rising urbanization (a combination of rural-to-urban migration and population growth) on one hand and fund crunch on the other put severe pressure on our cities’ already crumbling infrastructure. Besides, an unprecedented rise in prices of commodities, across the board, over the last few years too has hit the ever-constrained finances of urban local bodies hard. These make the task of developing new infrastructure really hard for ULBs, unless there is a strong financial support coming from the central/state government or other agencies like World Bank.

However, given India’s huge infrastructure deficit, the country requires massive investment to build and develop infrastructure like highways, healthcare, ports, airports, and even education. This makes the role of the private sector quite crucial for the two simple reasons – first, private sector participants can bring in the funding at such large scale, provided such investments have the potential to fetch good returns; second, private sector brings with it the required technical and managerial skills and also experience, which the public sector may be lacking in. Besides, private sector is viewed as being more productive and efficient as compared to their public sector counterparts. Aside, this (PPP) also enables the government to liberate and hence allocate vital resources to other activities for public good. According to Wikipedia, “Public-private partnership (PPP) describes a government service or private business venture which is funded and operated through a partnership of government and one or more private sector companies.”

The Government of India’s renewed thrust on bringing private sector investment in building and upgrading its infrastructure is slowly yielding the results. According to the Economic Survey 2007-08, “India has witnessed a rapid increase in private investment in infrastructure over the last five years.” Not only that India even betters other BRIC nations like China and Brazil (the other being Russia) when it comes to bringing in private sector participation in infrastructure development. In 2006, commitments to Indian infrastructure projects with private participation were around double that of Brazil and China, making India the leader amongst the middle and low income countries.

Given that, the Public-Private Partnership has emerged as a viable model for developing countries like India to give a boost to the infrastructure development. However, to reap the true benefits of private sector participation requires meticulous planning, on part of the government and governmental bodies like ULBs, which includes among others things like identify the objectives clearly, proper evaluation of the costs and sources of funding, setting up of a monitoring and coordinating body, and realistic estimates of the return. Also, it is equally important to select the proper mode of the PPP. The main defining feature of PPPs is the degree of private control over and involvement in financing. The next section discusses some of the major types of PPP models.

Types of PPPs

There are five major categories of public-private partnerships; some of these categories also contain several variants. ‘These models vary mainly by Ownership of capital assets, Responsibility for investment, Assumption of risks, and Duration of contract.

Types of PPP Schemes – At a Glance

Schemes Modalities

Service contracts The private party procures, operates and maintains an asset for

a short period of time. The public sector bears financial and

management risks

Operation and management The private sector operates and manages a public owned

contracts asset. Revenues for the private party are linked to performance

targets. The public sector bears financial and investment risks

Leasing-type contracts The private sector buys or leases an existing asset from the

• Buy-build-operate (BBO) government, renovates, modernizes, and/or expands it, and

• Lease-develop-operate (LDO) then operates the asset, again with no obligation to transfer

• Wrap-around addition (WAA) ownership back to the government

Build-operate-transfer (BOT) The private sector designs and builds an asset, operates it, and

• Build-own-operate-transfer (BOOT) then transfers it to the government when the operating contract

• Build-rent-own-transfer (BROT) ends, or at some other pre-specified time. The private partner

• Build-lease-operate-transfer (BLOT) may subsequently rent or lease the asset from the government.

• Build-transfer-operate (BTO)

Design-Build-Finance-Operate (DBFO) The private sector designs, builds, owns, develops, operates

• Build-own-operate (BOO) and manages an asset with no obligation to transfer ownership

• Build-develop-operate (BDO) to the government. These are variants of design-build-finance-

• Design-construct-manage-finance (DCMF) operate (DBFO) schemes.

Source: http://www.europarl.europa.eu/comarl/imco/studies/studies/0602_ppp_briefingnote_en.en.pdf

The major categories of PPP model are:

• Service Contracts,

• Operations and Management Contracts,

• Leases,

• Build-Operate-Transfer (BOT) Contract and its Variants, and

• Concession Agreements.

• Service Contracts

In service contracts, the private party is entrusted with the task of performing non-core activities in lieu of fees. This type of contract is also sometimes referred to as outsourcing. In this form of PPP, the private sector participant is entrusted with the task of procurement, operations and maintenance, while the government retains the ownership. Service contracts have a short duration, ranging from six months to a few years. The private party has to bear the financial and residual value risk.

The main objective in this type of PPP is to benefit from the operational efficiency and technical expertise of the private sector. In other words, the government benefits from the operational efficiency of the private sector without having to transfer the control over the quality of outputs. This mode is more suitable for projects like toll collection services, for the provision and maintenance of vehicles or other technical activities. Examples include cafeteria, security services etc. at government establishments. This form of PPP is suitable in cases where there is a wider opposition from common public about privatization of public (utility) services such as water or in cases where there is a need for the government to reduce its role and improve service efficiency.

Operations and Management Contracts

In this form of PPP, the onus of asset operation and management is on the private party while the ownership rests with the government. The duration of such contracts may range from three to five years, however, the same may be extended, depending on the nature and complexities of the projects. The investment and financial risk is borne by the government. The main objective of this type of contract is to benefit from the efficiency gains and technological know-how of

the private sector. Such contracts can also be useful in the transition stage leading to total divestiture or privatization.

Management contracts are useful options in preparing for PPP where

• The regulatory framework needs to be upgraded;

• Tariffs are too low and government needs time to develop a system of subsidies;

• Stakeholders have not yet agreed to long-term involvement of the private sector; or

• The country has no record of experience of public-private partnerships.

How they Compare?

Leases

In this model, ‘the private party purchases the income streams generated by publicly-owned assets in exchange for a fixed lease payment and the obligation to operate and maintain the asset.’ While the responsibility of planning and raising new investments rests on the government, the private party bears the commercial and demand risks. Therefore, in this type of PPP, the private party has every incentive to reduce the overall costs and improve operational efficiency. Leasing Agreements are appropriate for services such as public utilities like urban transport which can generate independent revenue streams.

Build-Operate-Transfer (BOT) Contracts and Variants

Also called Turnkey Procurement, in this type of PPP, the private sector participant owes the responsibility of designing, building and operations of the asset. Once again the ownership lies with the public sector while the private party bears the commercial risk. The BOT model has several stripped down/stepped up versions like BOOT (Build-Own-Operate-Transfer), BROT (Build-Rehabilitate-Operate-Transfer), BLOT (Build, Lease, Operate, Transfer) and BTO (Build, Transfer, Operate).

This model is best suited for projects which require massive funding and also involve building new infrastructure. These projects are also essentially of long gestation period. This kind of PPP model is generally used in public utilities such as building new power plants, drinking water supply, waste water treatment plants etc. Once again, the private operator has to meet the guidelines/specifications set by the public entity. However, a major drawback of this model

is that ‘the length and complexity of BOTs make these contracts difficult to design, a fact that often negates the positive effects of the initial competition.’

Concessions

Under concession contracts, a private operator is given a contractual right to use existing infrastructure assets to supply customers and to finance and manage all capital extensions and upgrades to the existing services supplied. The duration of this type of PPP is much longer than that in case of leasing agreement model.

A major characteristic of this model is that the private party bears the responsibility of both investment as well as operations and maintenance of the asset. However, the ownership once again, like in case of other models, rests with the public entity. The governments wrest the control of the asset back after the expiry of the concessions agreement period. Concessions model differs from the Leases model in the sense that in the latter the funding responsibility lies with the public sector or the government.

Outlook

By 2021, the share of India’s urban population will jump from the present 28% (of the overall population) to 40%, according to the ES 2007-08. That means by that time all the basic civic services like water supply, sanitation, solid waste, urban transport would have to accordingly be scaled up to meet with the jump in demand for such services. But are our ULBs equipped and geared up to meet these challenges? Definitely not. Against this backdrop, there is no denying the fact that the PPP model is the need of the hour, especially in the case of the developing economies. In case of geographically vast countries like India the challenges before the governments are all the more enormous. However, at the same time, this also presents immense opportunities for the private sector. For instance, according to the Economic Survey (ES) 2007-08, “The Eleventh Five Year Plan envisages total investment in physical infrastructure (electricity, railways, roads, ports, airports, irrigation, urban and rural water supply and sanitation) to increase from around 5 per cent of GDP in 2006-07 to 9 per cent of GDP by the end of the plan period if the targeted rate of growth of 9 per cent for the Eleventh Five Year Plan period (2007-12) is to be achieved.” Further, total investment in creating physical infrastructures such as roads, railways, ports, power, electricity, sanitation etc., would alone require a massive Rs.2,000,000 crore (or approx. $400 bn) during the said plan, as per the ES. The private sector’s investment is projected at one-third of the overall investment envisaged.

To ensure smooth function and success of the PPP model in the country, the government has already initiated several measures which are expected to give a big boost to the Public Private Partnership model in the days to come. To conclude, surely, this presents huge opportunities for the private sector to play and benefit by participating in the economic development process of the nation.

N Janardhan Rao, Lead Economist.