The Rise of India’s Drug Industry

One of the great success stories in international trade in recent years has been the strong growth of
India’s pharmaceutical industry. The country used to be known for producing cheap knockoffs of
patented drugs discovered by Western and Japanese pharmaceutical companies. This made the
industry something of an international pariah. Because they made copies of patented products, and
therefore violated intellectual property rights, Indian companies were not allowed to sell these
products in developed markets. With no assurance that their intellectual property would be
protected, foreign drug companies refused to invest in, partner with, or buy from their Indian
counterparts, further limiting the business opportunities of Indian companies. In developed markets
such as the United States, the best that Indian companies could do was to sell low-cost generic
pharmaceuticals (generic pharmaceuticals are products whose patents have expired). In 2005,
however, India signed an agreement with the World Trade Organization that brought the country into
compliance with WTO rules on intellectual property rights. Indian companies stopped producing
counterfeit products. Secure in knowledge that their patents would be respected, foreign companies
started to do business with their Indian counterparts. For India, the result has been dramatic growth
in its pharmaceutical sector. The sector generated sales of close to $30 billion in 2012, more than
two and a half times the figure of 2005. Driving this growth have been surging exports, which grew at
15 percent per annum between 2006 and 2012. In 2000, pharmaceutical exports from India
amounted to around $1 billion. By 2012, the figure was around $14 billion! Much of this growth has
been the result of partner-ships between Western and Indian firms. Western companies have been
increasingly outsourcing manufacturing and packaging activities to India while scaling back some of
these activities at home and in places such as Puerto Rico, which historically has been a major
manufacturing hub for firms serving the U.S. market. India’s advantages in manufacturing and
packaging include relatively low wage rates, an educated workforce, and the widespread use of
English as a business language. Western companies have continued to perform high value-added
R&D, marketing, and sales activities, and these remain located in their home markets. During India’s
years as an international pariah in the drug business, its nascent domestic industry set the
foundations for today’s growth. Local start-ups invested in the facilities required to discover and
produce pharmaceuticals, creating a market for pharmaceutical scientists and workers in India. In
turn, this drove the expansion of pharmaceutical programs in the country’s universities, thereby
increasing the supply of talent. Moreover, the industry’s experience in the generic drug business
during the 1990s and early 2000s has given it expertise in dealing with regulatory agencies in the
United States and European Union. After 2005, this know-how made Indian companies more
attractive as partners for Western enterprises. Combined with low labor costs, all these factors came
together to make India an increasingly attractive location for the manufacturing of pharmaceuticals.
The U.S. Federal Drug Administration (FDA) responded to the shift of manufacturing to India by
opening two offices there to oversee manufacturing compliance and make sure safety was
consistent with FDA-mandated standards. Today, the FDA has issued approvals to produce
pharmaceuticals for sale in the United States to some 900 plants in India, giving Indian companies a
legitimacy that potential rivals in places such as China lack. For Western enterprises, the obvious
attraction of outsourcing drug manufacturing to India is that it lowers their costs, enabling them to
protect their earnings in an increasingly difficult domestic environment where government health
 care regulation and increased competition have put pressure on the pricing of many
pharmaceuticals. Arguably, this also benefits consumers in the United States because lower
pharmaceutical prices mean lower insurance costs, smaller copays, and ultimately lower out-of-
pocket expenses than if those pharmaceuticals were still manufactured domestically. Offset against
this economic benefit, of course, must be the cost of jobs lost in U.S. pharmaceutical manufacturing.
Indicative of this trend, total manufacturing employment in this sector fell by 5 percent between 2008
and 2010.
Case Discussion Questions
1. How might (a) U.S. pharmaceutical companies and (b) U.S. consumers benefit from the rise of the
Indian pharmaceutical industry?

2. Who might have lost out as a result of the recent rise of the Indian pharmaceutical industry?
3. Do the benefits from trade with the Indian pharmaceutical sector outweigh the losses?
4. What international trade theory (or theories) best explain the rise of India as a major exporter of
pharmaceuticals?

1. How might (a) U.S. pharmaceutical companies and (b) U.S. consumers benefit from the
rise of the Indian pharmaceutical industry?

 U.S. Pharmaceutical Companies benefit primarily through cost savings. By

outsourcing manufacturing and packaging to India, they reduce production expenses due
to India's lower labor costs, without sacrificing quality since India has FDA-approved
facilities. This allows them to remain competitive and maintain profit margins in a global
market where pricing pressures are increasing.
 U.S. Consumers benefit from lower drug prices. The cost savings that U.S.
pharmaceutical companies gain by outsourcing are often passed on to consumers through
lower-priced generics, which reduce insurance premiums, copays, and out-of-pocket
expenses for prescription drugs. This is particularly important as healthcare costs rise.

2. Who might have lost out as a result of the recent rise of the Indian pharmaceutical
industry?

 U.S. Pharmaceutical Manufacturing Workers may have lost jobs as companies shifted
production to India. Between 2008 and 2010, manufacturing employment in the U.S.
pharmaceutical sector declined by 5%, reflecting the shift overseas. These job losses
impact workers and local economies, particularly in regions that historically depended on
pharmaceutical manufacturing.
 Puerto Rico also faced economic challenges as companies scaled back operations there
in favor of Indian plants, reducing employment and economic stability in areas that
traditionally supported U.S. pharmaceutical production.
3. Do the benefits from trade with the Indian pharmaceutical sector outweigh the losses?

The benefits of trade with India’s pharmaceutical sector likely outweigh the losses when viewed
from an economic efficiency perspective. The benefits include:

 Lower costs for U.S. consumers and pharmaceutical companies, making healthcare
more affordable and ensuring competitive pricing in a global market.
 Increased investment in India boosts the industry’s compliance with international
standards, benefiting U.S. consumers by ensuring access to safe, affordable medications.

However, job losses in U.S. manufacturing and the economic impact on regions like Puerto
Rico are significant drawbacks. Policymakers must weigh these localized losses against broader
consumer and economic benefits when assessing the overall value of this trade relationship.

4. What international trade theory (or theories) best explain the rise of India as a major
exporter of pharmaceuticals?

 Comparative Advantage Theory: India’s lower labor costs and growing expertise in
manufacturing provide a comparative advantage in pharmaceutical production. This
allows India to specialize in manufacturing while the U.S. focuses on high-value
activities like R&D and marketing, which aligns with the theory's emphasis on countries
exporting goods where they have lower opportunity costs.
 Factor Endowment Theory (Heckscher-Ohlin Model): India has an abundance of
educated labor at relatively low wages, making it an ideal location for labor-intensive
pharmaceutical manufacturing. The U.S., by contrast, has a high supply of capital and
advanced technology, so it focuses on capital- and technology-intensive aspects of the
pharmaceutical industry.
 Product Life Cycle Theory: Initially, pharmaceutical innovations were concentrated in
the U.S., but as the industry matured, India took over manufacturing aspects, especially
for generic drugs. This shift mirrors the theory's prediction that, over time, production
moves to lower-cost countries as products become standardized.

Case Study 4
Foreign Retailers in India
For years now, there has been intense debate in India about the wisdom of relaxing the country’s
restrictions on foreign direct investment into its retail sector. The Indian retailing sector is highly
fragmented and dominated by small enterprises. Estimates suggest that barely 6 percent of India’s
almost $500 billion in retail sales take place in organized retail establishments. The rest takes place
in small shops, most of which are unincorporated businesses run by individuals or households. In
contrast, organized retail establishments account for more than 20 percent of sales in China, 36
percent of sales in Brazil, and 85 percent of all retail sales in the United States. In total, retail
establishments in India employ some 34 million people, accounting for more than 7 percent of the
workforce.

Advocates of opening up retailing in India to large foreign enterprises such as Walmart, Carrefour,
Ikea, and Tesco, make a number of arguments. They believe that foreign retailers can be a positive
force for improving the efficiency of India’s distribution systems. Companies like Walmart and Tesco
are experts in supply chain management. Applied to India, such know-how could take significant
costs out of the economy. Logistics costs are around 14 percent of GDP in India, much higher than
the 8 percent in the United States. While this is partly due to a poor road system, it is also the case
that most distribution is done by small trucking enterprises, often with a single truck, that have few
economies of scale or scope. Large foreign retailers tend to establish their own trucking operations
and can reap significant gains from tight control of their distribution system.
Foreign retailers will also probably make major investments in distribution infrastructure such as cold
storage facilities and warehouses. Currently, there is a chronic lack of cold storage facilities in India.
Estimates suggest that about 25 to 30 percent of all fruits and vegetables spoil before they reach the
market due to inadequate cold storage. Similarly, there is a lack of warehousing capacity. A lot of
wheat, for example, is simply stored under tarpaulins, where it is at risk of rotting. Such problems
raise foods costs to consumers and impose significant losses on farmers.
Farmers have emerged as significant advocates of reform. This is not surprising because they stand
to benefit from working with foreign retailers. Similarly, reform-minded politicians argue that foreign
retailers will help to keep food processing in check, which benefits all. Ranged against them is a
powerful coalition of small shop owners and left-wing politicians, who argue that the entry of large,
well-capitalized foreign retailers will result in the significant job losses and force many small retailers
out of businesses.
In 1997, it looked as if the reformers had the upper hand when they succeeded in changing the rules
to allow foreign enterprises to participate in wholesale trading. Taking advantage of this reform, in
2009 Walmartstarted to open up wholesale stores in India under the name Best Price. The stores
are operated by a joint venture with Bharti, an Indian conglomerate. These stores are only allowed to
sell to other businesses, such as hotels, restaurants, and small retailers. By 2012, the venture had
20 stores in India. Customers of these stores note that unlike many local competitors, they always
have products in stock, and they are not constantly changing their prices. Farmers, too, like the joint
venture because it has worked closely with farmers to secure consistent supplies and has made
investments in warehouses and cold storage. The joint venture also pays farmers better prices—
something it can afford to do because far less produce goes to waste in its system.
For its part, in 2011 the Indian government indicated that it would soon introduce legislation to allow
foreign enterprises like Walmart entry into the retail sector. On the basis on this promise, Walmart
and Bharti were planning to expand downstream from wholesale into retail establishments, but their
plans were put on hold in late 2011 when the Indian government announced that the legislation had
been shelved for the time being. Apparently, opposition to such reform had reached such a pitch that
implementing it was not worth the political risk. Opponents argued that global experience showed
that FDI leads to job losses, although they cited no data to support this claim. Whether India will
further relax regulations limiting inward FDI into retail remains to be seen.
Case Discussion Questions
1. Why do you think that the Indian retail sector is so fragmented?
2. What are the potential benefits to India of entry by foreign retail establishments? Who are the
potential losers here?
3. Who stands to lose as a result of foreign entry into the India retail sector?
4. Why do you think reform of FDI regulations in India has been so difficult?

1. Why do you think that the Indian retail sector is so fragmented?

The Indian retail sector’s fragmentation can be attributed to several factors:

 Historical and Cultural Preference for Small Shops: Many Indian consumers are
accustomed to shopping at small, local stores (kiranas) where they often have personal
relationships with shopkeepers.
 High Entry Barriers for Organized Retail: Large-scale retail requires significant
infrastructure and capital investment, which many smaller players cannot afford.
Additionally, regulatory barriers have historically restricted foreign direct investment
(FDI) in the retail sector.
 Supply Chain Limitations: India’s distribution system relies heavily on small-scale,
decentralized trucking and logistics providers, which limits the ability of large retailers to
gain the economies of scale typically found in more organized sectors.
 Lack of Organized Retail Space: With a shortage of affordable, large-scale retail
locations, small, independent retailers find it easier to set up business in smaller, more
flexible spaces.

2. What are the potential benefits to India of entry by foreign retail establishments?

The entry of foreign retailers could bring several potential benefits:

 Improved Supply Chain Efficiency: Foreign retailers like Walmart and Tesco have
expertise in supply chain management, which could reduce India’s high logistics costs
and improve distribution efficiency.
 Investment in Infrastructure: Foreign retailers are likely to invest in essential
infrastructure, such as cold storage and warehouses, reducing food waste, enhancing food
security, and improving product availability.
 Better Pricing for Farmers: By streamlining distribution and reducing spoilage, foreign
retailers can afford to pay farmers higher prices, ensuring a more consistent market for
their products.
  Lower Prices and Improved Variety for Consumers: Increased competition from
foreign retailers could drive down prices, benefiting consumers with lower costs and
more product choices.

3. Who stands to lose as a result of foreign entry into the India retail sector?

The primary potential losers include:

 Small Retailers and Shop Owners: These individuals, who make up a large portion of
India’s retail sector, may be unable to compete with the economies of scale and lower
prices offered by large foreign retailers, leading to business closures and job losses.
 Small-Scale Distributors and Trucking Companies: Foreign retailers often prefer to
establish their own logistics networks, which could displace small logistics providers who
rely on small-scale, fragmented distribution.
 Regional Suppliers and Wholesalers: If foreign retailers opt to buy directly from
producers (like farmers), local wholesalers who traditionally play a middleman role may
see a decrease in business.

4. Why do you think reform of FDI regulations in India has been so difficult?

FDI reform in India’s retail sector faces challenges for several reasons:

 Political Sensitivity and Job Concerns: Small retailers and their supporters, especially
left-wing politicians, argue that foreign investment would lead to job losses in the small
retail sector, threatening the livelihoods of millions of people.
 Public Sentiment and Populist Pressures: Local communities tend to support small
shops as they provide personalized services. There is concern that foreign retailers could
disrupt the traditional shopping experience and culture.
 Strong Lobbying by Local Business Groups: Small retailers and traders have
significant influence and are well-organized in lobbying against reforms that threaten
their businesses.
 Historical Reluctance Toward Foreign Influence: India has a historical wariness about
opening up sectors to foreign investors, especially in areas directly affecting the daily
lives of its citizens, due to fears of economic dependency and influence.

Overall, the intense lobbying by small shop owners, the political significance of protecting local
jobs, and cultural factors make FDI reform in the retail sector a complex and politically
challenging issue for the Indian government.