Chapter 3: Foreign Capital Inflow and Expansion of Subcontracting in the Informal Manufacturing Sector: A General Equilibrium Approach

This chapter conducts a comprehensive examination of the influence of Foreign Direct Investment (FDI) on the manufacturing sector in India, with a particular focus on the informal manufacturing sector's growth and expansion through subcontracting mechanisms. This analysis employs a general equilibrium approach to explore the ramifications of FDI inflows on the dichotomous sectors of manufacturing: the formal and informal. The influx of FDI into the formal sector is identified as a catalyst that propels these firms to enhance production and adjust their factor utilization, which in turn leads to an escalation in contractual employment. However, this surge encounters resistance from labour unions, which compels formal sector firms to enter into subcontracting arrangements with entities within the informal manufacturing sector. This transition proves to be advantageous for the informal sector, witnessing an uplift in both output and employment levels, thereby contributing to a decrease in overall unemployment rates and a potential uptick in wages. Moreover, this pivot towards subcontracting practices is posited to result in reduced carbon emissions emanating from the larger entities within the formal manufacturing domain. This chapter elucidates the dynamic interrelation between India's formal and informal manufacturing sectors as significantly impacted by foreign capital influx, emphasizing the critical role of subcontracting in enhancing the productivity and output of the informal sector. It advocates for governmental policies to support and bolster this interconnection. It also paves the way for future empirical investigations into the intricate dynamics of FDI, subcontracting, and their broader socio-economic impacts on the Indian economy.