There’s only one relevant question to ask foreign investors eyeing India’s arms sector

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Investment or foreign direct investment is seen as a panacea for everything—a piece of conventional wisdom you see espoused every day by some expert or other. After the new Indian government was sworn in, the clamour for FDI in defence has reached a peak. The noise is so loud that the defence minister is reported to be seriously contemplating it.

Almost every problem in defence—including slowdown in defence procurement and defence preparedness—is expected to get resolved by allowing 100% foreign ownership in the sector. This is the moment to pause. What is at stake here?

Permitting FDI in defence has huge ramifications for geo-political relationships, the economy and jobs.  India is the largest importer of defence equipment in the world, accounting for 14% of international arms imports. Some 75% of India’s arms come from Russia, a legacy of the Cold War. The US accounts for just 7%. If New Delhi were to allow FDI in the sector, US and European companies would benefit.

From India’s point of view, the question to consider it is how many jobs FDI in defence could generate. Creation of jobs is vital for India. According to data from the National Sample Survey Organization, employment-generation rate during 2010-12 was a low 2.2%. This has led to a 16.3% unemployment rate among youth who are graduates.

So far, foreign companies are allowed only a 26% stake in defence companies. Indian companies want this limit to continue. This level gives Indian businesses a profitable exit option. In the past, Indian lobbying body FICCI has opposed proposals to raise the limit of foreign companies in the defence sector to 51%.

Lobbyists for FDI argue that multinational corporations will bring technology and inputs only if they have majority of full control over their investment.  They claim that this investment will create two million jobs—but it isn’t clear how this will happen. Technology transfers do not necessary result in jobs or local production.

In the past, foreign companies have been reluctant to transfer core technology. Even for mass consumer items like mobile phones and computers, core technology is never transferred. Instead, components are imported and assembled to meet local production requirements. Nokia’s plant in Sriperambudur, Tamil Nadu, for instance, added local software and regional keyboards and assembled the core unit (before it was orphaned following a tax claim). But all components are manufactured abroad. Only the charger, which uses the lowest level of technology, is manufactured by its vendor Foxxconn in India.  The lack of technology transfer is evident from the low wages: workers in this factor earned Rs6,000 per month on average.

There is even a fallacy that allowing MNCs into India with 100% stakes will ensure that their technology will percolate into the country and result in domestic production. This argument is made by geo-political experts with little understanding of how business works. A fully foreign-owned Indian company will act as little more than a tax optimizing agent to benefit from the country’s free trade agreements with various low-tax nations. When multi-national companies set up Indian arms, they end up importing from countries like Singapore or Dubai (FTZ) to India. Fully owned Indian companies are preferred as all the benefit of transfer pricing can be captured and taxes avoided. When Indian government pressurises them to begin manufacturing, they set up assembly units. Almost every device or mobile maker uses either a fully owned subsidiary or one of the large distributors to import into the country. None of this results in creation of jobs of any value in India.

FICCI and other domestic lobbying bodies have been insisting on minimum capitalization of $100 million as a requirement for allowing FDI. Again the capitalization of the company does not necessarily solve the issue. A high level of capitalization does not mean that it will result into investments or jobs.

Instead, the policy should specify how many jobs the company should create for every million dollars of its contract with the government. It should state how these jobs will scale up in value and expertise over the period of the deal. Companies giving the most appealing option should be given the contract, all other conditions remaining the same. The debate needs to shift away from companies to people, and the people want jobs.