FDI infrastructure - a transaction costs approach

Abstract

Introduction The importance of infrastructure in the growth of any country can never be undermined. They are in essence a set of industries that are viewed as ‘essential’ for economic development, societal progress, human well being. No wonder they receive undisputed attention, the world over, from any that is serious about economic growth. But the reasons why they receive that go beyond the significant role they play in any development. It is the inherent characteristics of infrastructure industries that set them apart. To start with, infrastructure goods have aspects of public goods. They are mostly nonexcludable i.e. one cannot stop another from enjoying their benefits. At the same time they are also non-rivalrous to some extent. Consumption by one does not reduce the availability for another. Being public goods, the ideology at the time was that of public provision. Even in market oriented economies, in case of public goods and infrastructure, public provision as the rule. Another important characteristic of infrastructure industries is that they are highly land intensive. This leads to several issues of the nature of “right of way”. The trade-off between environmental impacts and societal gains becomes inevitable. Even in societal gains, questions arise as to the legitimacy of social displacement of some for the larger good. The third feature of infrastructure industries is the contract with the government. Since all infrastructure industries were earlier government monopolies, and even after privatization involve a contract with the government to provide a service to the public. Other thandefense, no other industry involves a long-term interaction with the government. With the government having power and motives over and above that of a normal contractual party,this makes infrastructure projects a greater challenge.One of the biggest problems associated with infrastructure has been that of free riders. Being largely non-excludable, the benefits received are by all. But payment for those benefits is made only indirectly through payment of taxes. This makes the process of price discovery for infrastructure very difficult. On the other side, externalities, both positive and negative, further hinder this process. The aim of this paper is to study FDI in infrastructure in India and China from a transaction costs perspective. We essentially look at growth of FDI in these rising giants. We then study the transaction costs, both ex ante and ex post that an investor has to put up with in both these countries an how that affects the level of FDI there. Our sector focus has been on Telecommunications and Power. What makes these sectors unique even within the domain of infrastructure is their network. Both these industries run on networks, which adds new dimensions to their structure. The most striking one is the existence of natural monopolies. Also, network externalities have a role to play. There is the Network effect wherein the value of the network increases as every new member joins the network. A corollary of the network effect lies in the existence of free riders that gain from the network but don’t pay for it. All these factors make the process of price discovery even more difficult. We shall see in the subsequent sections the various transaction costs that are laden on power andtelecommunication companies due to these inherent characteristics of their industries.