A concentration problem: Policymakers should support markets, not champions

It has long been understood that one of the malign consequences of tariff walls, combined with domestic subsidies for industry through focused “industrial policy,” is the growth of entrenched industrial conglomerates. Indian policymakers should have understood this better than most, given that this was part of the country’s economic history after independence. It was not until the 1990s that liberalisation created some churning in the economy. There are worrying signs, however, that in the most recent phase of the Indian economy, aspects of this post-liberalisation trend have begun to be reversed. As economist Ajay Chhibber has pointed out in these pages, some recent research has shown that industrial concentration — the dominance of sectoral output by a small set of bigger firms — has grown over the past decade. This has been accompanied by an increase in these companies’ pricing power — their ability to generate revenue over their variable costs. There are also problematic findings about the salience of competition for such sectors, with faster-growing sectors paradoxically having higher barriers to entry, and with new entrants being negatively correlated with the size of the firms currently in the sector. 

A disturbing picture emerges if these pieces of evidence are put together. India’s growth has come to rely on the investment and operational choices of a relatively small number of large business groups, many of which continue to be controlled by specific families. Such a structure does not necessarily lead to productive investment, or provide consumers the benefits associated with competitive pressures. As investor and commentator Akash Prakash recently highlighted in these pages, Indian businesses are more focused on short-term profits than investment. Why, then, is this form of market structure taking hold? Partly it may be because some of the most productive sectors at the moment — telecommunications and e-retail, for example — feature network externalities that advantage incumbents of size. But it must also be acknowledged that a large share of the blame must accrue to deliberate policy choices. 

  India’s conscious decision to return to industrial policy and state-guided investment has had the inevitable consequence of empowering the largest conglomerates. The government will find it easier to cooperate with such entities rather than designing policies to incentivise a host of smaller players. Some will argue that this is not necessarily bad news for growth and productivity. After all, countries like Japan, South Korea, and even the United States, during the “gilded age” of the late 19th century, grew fast through using what were variously called zaibatsus, chaebols, or “robber barons”. These cooperated with the state to build new sectors like railways or electronics. The difference, however, is that they also improved efficiency because they were not always protected by tariff walls and were encouraged to focus on the export market. 

National champions abroad may provide some dubious mercantilist utility; national champions at home are clearly a problem. As former Reserve Bank of India governor Raghuram Rajan has pointed out, India’s new breed of national champions is not exactly creating world-beating new products or internationally renowned brands. It could also be argued that they are soaking up investible resources, which might be more effectively deployed elsewhere. The fundamental problem lies not with these companies, which are simply maximising profits as they should. The error lies in the direction of policy, which should increase economic openness and reduce government control — but is instead doing the opposite.