Federalism and Foreign Direct Investment: How Political Affiliation Determines the Spatial Distribution of FDI – Evidence from India
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A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Sharma, Chanchal Kumar Working Paper Federalism and Foreign Direct Investment: How Political Affiliation Determines the Spatial Distribution of FDI – Evidence from India GIGA Working Papers, No. 307 Provided in Cooperation with: GIGA German Institute of Global and Area Studies Suggested Citation: Sharma, Chanchal Kumar (2017) : Federalism and Foreign Direct Investment: How Political Affiliation Determines the Spatial Distribution of FDI – Evidence from India, GIGA Working Papers, No. 307, German Institute of Global and Area Studies (GIGA), Hamburg This Version is available at: http://hdl.handle.net/10419/171296 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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Inclusion of a paper in the Working Papers serve to disseminate the research results of work in progress prior publicaton encourage exchange ideas and academic debate. Working GIGA GIGA Research Programme: Power and Ideas ___________________________ Federalism and Foreign Direct Investment: How Political Affiliation Determines the Spatial Distribution of FDI – Evidence from India Chanchal Kumar Sharma No 307 October 2017 www.giga-hamburg.de/workingpapers GIGA Working Papers 307/2016 Edited by the GIGA German Institute of Global and Area Studies Leibniz‐Institut für Globale und Regionale Studien The GIGA Working Papers series serves to disseminate the research results of work in progress prior to publication in order to encourage the exchange of ideas and academic debate. An objective of the series is to get the findings out quickly, even if the presenta‐ tions are less than fully polished. Inclusion of a paper in the GIGA Working Papers series does not constitute publication and should not limit publication in any other venue. Copy‐ right remains with the authors. GIGA Research Programme “Power and Ideas” Copyright for this issue: © Chanchal Kumar Sharma WP Coordination: Melissa Nelson English‐language Copyediting of this Issue: James Morrison Editorial Assistance and Production: Silvia Bücke All GIGA Working Papers are available online and free of charge on the website <www.giga‐hamburg.de/workingpapers>. For any requests please contact: <workingpapers@giga‐hamburg.de> The GIGA German Institute of Global and Area Studies cannot be held responsible for errors or any consequences arising from the use of information contained in this Working Paper; the views and opinions expressed are solely those of the author or authors and do not necessarily reflect those of the Institute. GIGA German Institute of Global and Area Studies Leibniz‐Institut für Globale und Regionale Studien Neuer Jungfernstieg 21 20354 Hamburg Germany <info@giga‐hamburg.de> <www.giga‐hamburg.de> GIGA Working Papers 307/2016 Federalism and Foreign Direct Investment: How Political Affiliation Determines the Spatial Distribution of FDI – Evidence from India Abstract This paper links the foreign economic engagement of India’s states with the literature on federalism, thereby contributing to an understanding of the political economy of FDI in‐ flows in a parliamentary federal system. More specifically, it studies subnational govern‐ ments’ international engagements to attract foreign direct investment (FDI) and investi‐ gates whether the political affiliations of states’ chief ministers and parliamentarians de‐ termine the spatial distribution of FDI across the Indian states, correcting for the influence of per capita income, population density, urbanisation, infrastructure, policy regime, and human development. Although the central government plays no direct role in determining the state to which FDI goes, the centre–state relations in a federal structure play a role in creating perceptions about the relative political risk involved in different investment destinations. Employing multiple linear regressions to analyse time‐series (2000–2013) cross‐sectional (12 states) data using the panel procedure, the study finds that affiliated states attract relatively more FDI per capita in comparison to states ruled by opposition parties or coalition partners. How‐ ever, some exceptions do result, primarily due to two phenomena: first, the presence of a strong state leadership and, second, the presence of a significant share of members of par‐ liament belonging to the prime minister’s party in the non‐affiliated states. Further, states ruled by outside supporters have been most successful in attracting FDI inflows during the coalition period. Keywords: foreign direct investment, foreign policy, India, intergovernmental relations, economic growth JEL classification: F21, E22, G11, G23, P33, P45, P48, H70, H72, H73, H77 Dr. Chanchal Kumar Sharma is an associate at the GIGA German Institute of Global and Area Studies and a fellow at the Centre for Multilevel Federalism, Institute of Social Sciences, New Delhi. He teaches polit‐ ical science at the Central University of Haryana, Mahendergarh. <[email protected]>; ChanchalKumar.Sharma@giga‐hamburg.de <www.giga‐hamburg.de/en/team/sharma> 307/2016 GIGA Working Papers Federalism and Foreign Direct Investment: How Political Affiliation Determines the Spatial Distribution of FDI – Evidence from India Chanchal Kumar Sharma Article Outline 1 Introduction 2 Foreign Direct Investment in India: The Policy and the Politics 3 The Federal Political System Meets the Coalition Party System: Investors’ Dilemma of Safeguarding Investments from Political Risk 4 Hypotheses 5 Data and Methodology 6 Findings and Discussion 7 Conclusion Bibliography 1 Introduction India’s embrace of the free‐market paradigm in 1991 considerably expanded the economic policymaking autonomy of subnational governments (Kennedy 2013).1 Weak coalition gov‐ ernments in the 1990s further enhanced state‐level incumbents’ bargaining weight and the scope of their autonomous actions, unencumbered by the so‐called domination of the centre 1 This study is part of a larger project within a research group – comprising Sandra Destradi, Johannes Plagemann, and myself – that studies the impact of centre–state relations on subnational governments’ inter‐ national engagements in India. The paper has benefitted greatly from the detailed comments and input pro‐ vided by Sandra Destradi and Johannes Plagemann. GIGA Working Papers 307/2017 Chanchal Kumar Sharma: Federalism and Foreign Direct Investment in India 5 (Nooruddin 2010; Sinha 2007). The overall impact is captured in the term “federal market economy” (Rudolph and Rudolph 2001), which is defined as the rise of the states in arenas of economic decision‐making, with shared economic sovereignty and economic decentralisa‐ tion as the key hallmarks. This phenomenon was unmistakably marked by the centre’s di‐ minished influence and the states’ enhanced propensity and potential to seize opportunities. Foreign economic engagement is one such area in which states have increasingly demon‐ strated a capability to exercise substantial autonomy, especially since the late 1990s (Jha 1999; Singla 2017; Sridharan 2003; Wyatt 2017). Within this broader domain, the scope for states’ international engagement to attract foreign direct investment (FDI) is virtually unfettered (Vadlamannati 2012). This is because the union (or central) government itself has been en‐ couraging the states to take steps to improve their business environments and attract invest‐ ments (Maini 2016). The significance of FDI for a developing country such as India lies in its potential to catalyse economic development, promote employment opportunities, facilitate access to international markets, and generate technological and knowledge spillovers (OECD 2002). From a subnational perspective, foreign capital investments can boost subnational fi‐ nances and revitalise local economies. Since 2000, the phenomenon of Indian state governments sending high‐level delegations to a number of countries, conducting investment summits, and holding road shows to reach out to foreign investors has been on the rise. Realising the significance of foreign invest‐ ments, state governments are amending archaic central laws such as the Industrial Disputes Act, the Contract Labour Act, and the Factories Act. Overall, the frenzy to attract investment holds the potential to generate a race to the top2 among subnational governments