FDI in retail: An analysis

In the recent past there has been a lot of debate in the public domain pertaining to the government’s move to implement a new set of reforms, Foreign Direct Investment in the retail sector being one of them. I will try to weigh the arguments given by the government against the drawbacks of the policy and try to assess how this policy would affect the economy in the long run. The arguments that have been put forth by the government are-

1.      The FDI in retail would bring in investment into supply chain management and thus making it efficient as there is a substantial loss that is incurred in this area. Thus controlling inflation,

2.      It would raise employment

3.      Better prices to farmers as the middlemen would cease to exist

There are two sides to this story i.e. how the move will affect the backward linked markets to the retail sector and how the market for the retail will undergo a change by the entry of big retail.

Supply side story-

We have to accept the fact that our supply chain management is highly inefficient. At present the procurement for retail sale takes place in the following way, the small and marginal farmer is given a loan by the local money lender at an interest of about 36%, who hooks him up with a local middleman to whom he sells his crop. It is the journey from the middleman to the retail store is where the prices are jacked up; it is because of the absence of this process that makes farmers ’ markets beneficial to both the customer and the farmer. Now when the big retail firms enter the market, they will directly deal with the farmer or have their own contractors, and will eventually push the existing middlemen out, once this happens the big retail become a monopsony (single buyer, many sellers) or an oligopsony. These firms which get into contract farming, will have the power to reject the crop on quality basis, or with the excuse of a glut in the market and the firms will be able to force the farmers to produce unwanted crops like BT crops. In the short run the farmers might get a higher price for their crops but in the long run the market forces will give the retail chains enormous power which will manifest in lower prices to the farmers. Hence by allowing big retail firms to come in, we are replacing one oppressive structure by another oppressive structure. An alternate to this might be, the government itself investing in supply chain management, setting up of farmers cooperatives for procurement of loans and selling their products.

Demand side story-

There have been claims that the big retail firms will not lead to the ouster of the local mom & pop stores on the basis of the following arguments-

1.      The mom & pop stores have a personal connection to the customers which will enable them to give informal credit to the customers.

2.      The country is too big and can accommodate both the big and small retail.

3.      Big retail will be positioned at a geographically inconvenient location ( they will be located on the periphery of the cities as real estate prices will low)

All the arguments fall flat when we look at the modus operandi of big retail operates, they engage in competitive under-pricing to wipe out local competition. The ability of the big retail to firms to take losses for prolonged periods enables them to cut product prices by half or even by three fourths, prices at which the small retail shops cannot survive as they operate at the margin. So a lower middle class family which would save Rs.500 on a month’s groceries will opt for Wal-Mart. We have historical evidence of this behaviour, the strategic under-pricing that Pepsi and Coca Cola had engaged in, to wipe out local competition like Goldspot, Campa Cola, Thumbs Up and others led to the creation of a monopoly in the beverage industry, these two MNC’s are hugely profitable now. There is evidence from Indonesia, where 77% of the local retail stores were forced to shut down.  After they eliminate all local competition, the retail giants will eventually raise prices; surveys done in Madagascar have shown a 50% rise in the prise of products after the entry of big retail firms. The claim that the entry of large retail firms will raise employment is true in the short run but as the local small retail stores are pushed out of the market, unemployment will rise in the long run.     

The question to be asked now is over the necessity of FDI in retail and the source of its demand. It comes from, the elite middle class in the urban centres, who desire to have an experience out of grocery shopping, the Indian government which wants to sell the brand of India to spur animal spirits among investors and most importantly the politically influential Indian big capital who will own the remaining 49% of the retail chains. I don’t see any economic reason to replace the current local mom & pop stores, which operate in close to perfect competition conditions, which employ about 23million people with the big retail giants, other than political reasons.