Apr 16, 2012

Returns to scale in Electronics hardware manufacturing

There is an interesting report on "Measures to stimulate growth in IT/ITES and Electronic hardware industry". I tried to find out if they have come up with some innovative measures to stimulate the electronic hardware industry development in India. We have been struggling in this area for quite some time. Our semiconductor industry is still in its infancy, despite efforts by the Govt (through semiconductor policy and such), with not much hope of matching China/Taiwan or other East Asian economies in near future. Turn around the laptop or computer you are reading this blog on, and chances are, the hardware has come from China, Taiwan or one of the East Asian countries and not from India. Some random firmware or a bit of software on the computer might be from India, but that's more or less it. 

The report makes all the right noises about the problems in page 57, and comes up with recommendations from page 61 onwards. They cover both electronics hardware and semiconductors thoroughly. Semiconductors are given special attention and separately dealt in later pages of the report. The recommendations are wide ranging, covering tax rationalization to special incentives, investment boost, infrastructure and R&D facility developments and so on. The standard model of comparison is China, Taiwan and the emerging countries in this area like Vietnam and Malaysia.

I doubt if we can catch up even if all the recommendations are agreed and implemented, some of which may be challenged under WTO rules. My argument goes thus:

Electronics hardware (including semiconductors) industry mass produces the outputs at global level. I am not talking of the latest cutting-edge research products, but the general chips and electronic hardware we see commonly, like home appliances, computers, industrial control systems and machines. The returns to scale is important here. If I assume that the manufacturer somehow overcomes the investment barrier through lots of policy help from Govt. even then, he will face the problem of operating at a point where his economies of scale would not work in his favor. See the figure below. The average cost of the production for an increasing returns to scale industry will operate in the area where the curve is coming down. Our manufacturer will be operating to produce a lower quantity at Q, with an average cost of C, whereas the competitor who is operating at Q2, can manufacture the product at cost C1 which is much cheaper than C. So he will be having a competitive advantage. 
Returns to scale in electronics hardware manufacturing
The inquisitive mind might ask what if we do heavy investment and start mass producing at level Q2. The problem is, this approach will not work. There are other effects, such as learning effects, maturing of manufacturing technology and such, which also play a role to get there. Also, development of such a scale needs an entire cluster development of required ecosystem. The backward and forward integration is also important to get such scales. So, it is not feasible to just pour in huge money and get the scales. 

The second question is as to how countries like Vietnam and Malaysia are coming up. They came up in recent years. This is mostly due to Chinese industries, who are already enjoying huge economies of scale, using China plus one policy and spreading the risk to these countries. They are opening their manufacturing units in these countries to take advantage of lower labor costs relative to China. So, it's more of an extension of already existing scale economy. India has been unfortunate in this area too. Not much has come in into India in this area. 

What shall we do then? 
To start, we can do all that is recommended in the report. It might not help, but it will surely not harm. Also, we should be very clear about protecting and nurturing sunrise industries. To start, we should identify the next big things and start making right policies. Green technology might be one. Solar and renewable energy might be another area. We should be the pioneers. Even if we are not the pioneers, we should be ready to adapt once the product lifecycle enters a stage where the manufacturing technology is ready for adoption. Also, a trade barrier in such cases might help. Let our industry survive, we can think of free trade later. 

(Figure from wikipedia)