The FDI Effect: A Story of India’s Pharmaceutical Productivity

The Quest for Growth: Setting the Scene Imagine building a thriving local business, then watching as global giants enter your market. This was the reality for India’s pharmaceutical companies in the 1990s. But unlike typical David vs. Goliath stories, this one has a surprising twist: sometimes David grows stronger because Goliath is in town – but only under the right conditions.

A Tale of Two Eras

The Protected Years (1948-1970)

• Foreign companies dominated 80% of the market
• High drug prices burdened consumers
• Limited technology transfer to local firms
• Legal barriers prevented local manufacturing

The Transformation (1970-1990)

• New patent laws favored local innovation
• Foreign ownership limits encouraged partnerships
• Local companies mastered reverse engineering
• Domestic market share grew to 70%

The Global Dance: How Foreign Investment Shapes Local Success

The Positive Partners

1. The Competition Effect
   • Foreign firms raise the game
   • Local companies innovate to survive
   • Better resource use and technology adoption
2. The Knowledge Bridge
   • Skilled workers move between companies
   • New management practices spread
   • Quality standards improve
3. The Demonstration Effect
   • Local firms learn by observing
   • Advanced technologies become visible
   • Marketing strategies evolve
4. The Supply Chain Connection
   • Subcontracting creates opportunities
   • Technical assistance flows
   • Access to new markets opens

The Challenging Changes

1. Market Dynamics
   • Larger foreign firms gain advantages
   • Some small local firms struggle
   • Market concentration increases
2. Financial Access
   • Foreign firms get easier credit
   • Local firms face higher borrowing costs
   • Resource competition intensifies

The Surprising Discovery The research revealed an unexpected truth: having foreign companies in the market isn’t automatically good or bad for local firms. Success depends on two critical factors:

1. The size of the local company
2. Their investment in R&D

What Makes the Difference? Think of it like learning a new language:

• Just being around native speakers (foreign firms) isn’t enough
• You need both basic knowledge (R&D capability) and practice opportunities (market presence) to improve
• The bigger your vocabulary (company size), the more you can learn from complex conversations

Practical Lessons

For Policymakers

1. Focus on building local R&D capabilities
2. Support selective market concentration
3. Balance FDI openness with domestic capability building
4. Create technology transfer incentives

For Business Leaders

1. Invest in R&D before seeking foreign partnerships
2. Build scale to absorb foreign knowledge
3. Focus on technological capability development
4. Leverage international presence for learning

The Road Ahead The study suggests that India’s pharmaceutical success story isn’t just about opening doors to foreign investment – it’s about preparing local companies to walk through those doors and compete globally. The key isn’t just welcoming foreign investment, but building strong local capabilities that can turn foreign presence into domestic growth.

Academic Abstract:

The study tests the FDI spillover hypothesis in the Indian Pharmaceutical industry using an unbalanced panel data for a sample of firms over the period 1989-90 to 2000-01. The study estimates firm-specific productive efficiency growth for domestic firms from frontier production function and relates the same to a set of firm-specific attributes along with the variables of foreign presence. The study found that the presence of foreign firms per se may not be important for productivity growth of domestic firms unless it is complemented by the latter’s R&D activity or size. Therefore, the study concludes that policy efforts to encourage R&D and some concentration of size of the domestic firms in the industry may be more desirable than passively liberalizing the FDI policy from the point of view of increasing productive efficiency of local enterprises.

Learn More:

Full citation: Pradhan, Jaya Prakash (2002), ‘FDI Spillovers and Local Productivity Growth: Evidence from Indian Pharmaceutical Industry’, Artha Vijnana, 44(3–4), pp. 317–332, Publisher: Gokhale Institute of Politics and Economics.

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