The Hindu Business Line : Merits of good microeconomics

Competition among firms and the spectacular economic performance in recent years is principally the result of good microeconomics by the government. Firms have responded to the `new' microeconomics. Prof Michael Porter could choose to showcase India and India Inc. as proof that national wealth is actually created at the microeconomic level, says G. Ramachandran.

"Developing countries, again and again, are tripped up by microeconomic failures... countries can engineer spurts of growth through macroeconomic and financial reforms that bring floods of capital and cause the illusion of progress as construction cranes dot the skyline... Unless firms are fundamentally improving their operations and strategies and competition is moving to a higher level, however, growth will be snuffed out as jobs fail to materialise, wages stagnate, and returns to investment prove disappointing... India heads the list of low-income countries with microeconomic capability that could be unlocked by microeconomic and political reform."

— Michael Porter, of Harvard Business School, in Enhancing the Microeconomic Foundations of Prosperity: The Current Competitiveness Index, September 2001.

CONSTRUCTION cranes have yet to dot the skylines of India's metropolises but they soon will. However, firms have fundamentally improved their operations and strategies. Competition among firms has moved to a higher level, and the spectacular economic performance in recent years is principally the result of the practice of good microeconomics by the government.

There is compelling evidence to show that firms — the big, publicly-traded firms and the small, privately-financed ones — have responded to the `new' microeconomics. The merits of good microeconomics have begun to show up. Professor Michael Porter could choose to showcase India and India Inc. as proof that national wealth is actually created at the microeconomic level. Prof. Porter, the guru of competitiveness of nations and firms, has for long held the view that the prosperity of nations, regions, clusters and corridors is the direct and verifiable result of improvements in the capabilities at the microeconomic level.

He asserts that the wealth of nations, clusters and corridors is the result of the ability of firms to create valuable goods and services using productive methods. Microeconomic structures determine the ability of firms to be creative and productive. They are the vital determinants of national competitiveness and prosperity.

What, then, is the importance of macroeconomic policies and other institutions? Stable political and legal institutions and sound macroeconomic policies create the potential for improving national prosperity. They set the overall context for generating wealth and prosperity. But the generation of wealth and prosperity is dependent on execution, and execution clearly belongs to the set of capabilities of firms.

Firms exploit the potential for improving national prosperity by their action orientation and discipline of getting things done. The primacy of firms and their competitiveness is indisputable in the context of economic reforms and national competitiveness because firms are the doers. India's doers — the firms — have done well and they are set to accomplish more.

Riding the waves

India's economic reforms till date may be classified into two waves. The first wave began in 1991 and continues to roll on gingerly. The first wave, in the main, has addressed the potential for improving national prosperity.

Legal and regulatory institutions pertinent to corporate investments, corporate finance and issuance of securities, debt and equity markets, banking and insurance, commodity markets, and hedging and risk management are in place. India has implemented macroeconomic policies that govern interest rates and the price of the domestic currency.

The first wave has been quite successful. India's macroeconomic environment has been ranked ninth in the world. It is not surprising that India stood strong even as the countries that had too many construction cranes dotting the skylines suffered serious setbacks triggered by the macroeconomic crisis in 1997. The second wave began in 1998-99, and it too continues to roll on. The second wave has addressed some of the issues pertinent to the exploitation of the potential for improving national prosperity. Indian firms have responded favourably to the important changes at the microeconomic level. The second wave's intensity and purpose have been reinforced by their smart response. There has been little cavilling and quibbling. For a while the firms felt nervous, but the fight-forward has been breathtaking since then. India's firms are riding the waves.

Galloping elephant

If the quality of the national business environment were regarded as a proxy for the microeconomic environment, then the empirical evidence provided by Prof. Porter is informative and most encouraging. India's quality of national business environment had a global rank of 42 in 1998.

The rank improved by nine places — the biggest jump in the world — to 33 in 2001. By contrast, China improved its microeconomic rank from 44 to 41. India is ahead of China by eight places.

Only Iceland came close to India's breathtaking performance. Iceland's rank improved by eight places, from 23 to 15. But Iceland is a small economy that may be likened to a rabbit. India's economy is about 320 times as big as Iceland's in purchasing power terms. India may be likened to an elephant, and has performed as well as the rabbit by rapidly improving the quality of the business environment.

India has shown that an elephant can compete with a rabbit if the elephant's microeconomic structure and variables are configured right and implemented with unflagging zeal. When a nation reposes faith in the practice of good microeconomics, the constituents of the economy respond favourably and enthusiastically by smartly reconfiguring their operations and strategy.

Here's the proof, Prof.

India's company operations and strategy rank in 1998 was 50. It was 37 in 2001, a significant improvement by 13 places, the biggest jump in the world. Iceland's firms came closest to India's breathtaking performance. Iceland's rank improved by 12 places, from 28 to 16. By contrast, China's firms improved their operations and strategy rank by exactly one place: From 35 in 1998 to 34 in 2001. India's firms lag China's by merely three places.

The high correlation — at least in the case of smart winners — between the improvement in the quality of the national business environment and the company operations and strategy rank shows that firms respond to the microeconomic policies and intent of governments.

What is more, the direct and positive relationship between the national business environment and company operations and strategy is most striking in the case of India. No other country has reaped so much from microeconomic improvement as India has, and its firms have dared to be the most determined doers.

Constituents of India Inc. have acted as rabbits within an elephantine economic system. India Inc. has shown convincingly that microeconomic reforms can be made to work in favour of all segments of society when companies and their managers raise their performance to higher levels. India Inc. has since 1998-99 improved its managerial capability, creativity, effectiveness and responsiveness.

As a result, it has smartly improved its capital asset productivity, profitability from operations, value delivered to customers, and corporate tax paid to the exchequer (see Table). Consider the following.

First, productivity of capital assets measured by net sales to capital employed of a portfolio of 250 companies (almost all from the Business Line 250) rose 32 per cent between 1998-99 and 2001.

Second, sustainable profitability from operations measured by earnings before interest and taxes (EBIT) to capital employed increased by almost 8 per cent. Third, and by contrast, sustainable margin measured by EBIT to net sales decreased by more than 18 per cent.

Intense competition in the domestic economy produces results that are favourable to customers and consumers. It is clear that the benefits of the significant increases in capital asset productivity and sustainable profitability from operations were fully captured by customers of India Inc. in an aggressively competitive market.

Indian firms derived fewer and fewer cents as EBIT from a dollar of sales revenue in response to changes in the microeconomic structure. But they had not compromised the profitability of their capital employed. Sustainable profits of India Inc. rose by almost 8 per cent.

Customers of India Inc. have gained in a period characterised by a raft of microeconomic changes: Lower entry barriers to businesses, freedom of businesses to expand, lower excise duties, lower import tariffs and freer imports. Customers of India Inc. have gained because India Inc. has responded to the new microeconomics.

Government too has been a significant beneficiary of the rising productivity and profitability of India Inc. Corporate tax-to-capital employed surged by nearly 40 per cent. Corporate tax-to-net sales crept up by more than 5 per cent. Company operations and strategy have a noticeable impact on the fiscal health of government.

The significant improvement in corporate tax-to-capital employed shows that government cannot choose to be a bystander in the context of firms and their response to changes in microeconomic structure. India and India Inc. have successfully set off the "government-and-the-market'' wave in the pursuit of national competitiveness and prosperity.

(The author is a financial analyst. Feedback may be sent to indiagrow@sify.com)