Electronics industry: Policy choices for manufacturing success

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India's restrictions on tech imports may reshape the industry landscape and fuel domestic innovation.

The policy proposals put forward for the Indian electronics industry in a recent ICRIER Report titled Globalise to localise are grossly problematic. First of all, the Report obliterates Indian electronics industry’s existing globalisation experience of a quarter century, as discussed in the first part of this series. Further, its findings and policy proposals are based on two other fallacious analytical foundations: a theoretically incorrect conceptualisation of the critical economic concept of domestic value addition; and a partial presentation of the electronics industry development trajectories of China and Vietnam.

For a large economy like India, a singular focus on export growth to the exclusion of increasing domestic value addition, as the Report argues, is neither a necessary nor a desirable condition to make domestic electronics firms competitive. This is especially the case when there has already been very high competition in the domestic market since the Indian electronics industry began undergoing drastic tariff liberalisation 25 years ago under the WTO’s Information Technology Agreement (ITA-1).

The Report forces an artificial, exclusive focus upon exports through a twisted adaptation of the crucial economic concept of domestic value addition in its methodology and analysis.

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Methodological twist

Domestic Value Addition (DVA) in an industry is the total value of all domestic inputs used in total output of that industry, where total output is the sum of domestic sales and exports.

DVA = (Domestic sales + Exports) * DVAratio (1); wherein DVAratio is DVA per unit of total output.
However, the Report equates total output to exports and focuses on exports alone by formulating the following equation:

DVA= Exports * DVAratio (2)

While Section 2 claims that the Study uses the correct definition of DVA in terms of total output, Section 3 that presents stylised facts on domestic value addition is based on DVA content of exports alone. That is, the Report wrongly equates total output in the industry to exports. This incorrect construct (Equation 2) is used to argue that increasing export volume alone is sufficient for total DVA to increase, even when the DVAratio is falling or stagnating.

This wrong conceptualisation of domestic value addition is used to show that countries with higher electronic exports have lower DVAratio, which is in turn used to argue that it is not possible for countries to increase exports and raise domestic value addition simultaneously. The Report also found that countries with higher production of electronics (as a share of GDP) have higher DVAratio.

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There is no reconciliation of these two contrasting results. Attributing causation to an observed negative relationship between export scale and DVAratio also neglects the evidence that economies like South Korea or China which are well integrated into GVCs (and have high export scale), do have relatively high DVAratio compared with a country like Vietnam.

These contradictory results in total production and exports arise precisely because the Report does not integrate the role of their earlier sector-specific (or vertical) industrial policies in building up a strong indigenous production base that enabled the growth of GVC lead firms.

Let us consider the DVA concept in its totality. If there is exclusive policy focus on promoting exports (to the exclusion of a domestic value addition objective), increase in exports in specific electronics products (say, mobile phones or computers) will take place mainly through heightened imports of parts and components at zero duty.

At one level, such an import-dependent increase in exports reduces the domestic value addition per unit of output (DVAratio). At another level, rising imports will start displacing whatever domestic production has been taking place in parts and components, and cause a negative impact on total output.

Additionally, unlike earlier periods, when only exports had access to duty free imports of parts and components (and domestic market was protected), domestic demand for final products will also be increasingly met through import-dependent assembly (leading to further fall in DVAratio), or through direct imports of final goods (especially under zero duties on final goods). The latter will cause the displacement of domestic production of final products too.

In the absence of policy support for domestic value addition, the net impact on total industry output of the displacement of domestic production by imports (of parts and components, and final products) will depend on the actual increase in total import-dependent production for exports and domestic sales.

However, removal of duties (as suggested by the Report) will dis-incentivise both tariff-hopping FDI into Indian electronics manufacturing as well as domestic investments even by design-intensive indigenous entrepreneurs.

If India’s exports have to keep increasing, we must have either consistently rising external demand (that is, no economic slowdown in all our major export markets), or a consistent rise in unit export prices for such mass-produced mature products. India has no control over the latter two variables.

Moreover, the report neglects the fundamental economic role of domestic value addition in sustaining domestic production and employment, as well as in reducing macroeconomic vulnerabilities for the country arising from import-dependent production in an industry that is witnessing rapid demand growth because of accelerating economy-wide digitalisation.

Selective, narrow interpretation of country experiences

The ICRIER Report claims to have drawn on the experience of successful electronics exporting nations, and choses China and Vietnam as specific examples. According to the report, in the short-run, these two countries adopted policies that encourage companies to achieve global scale, even if it meant using fewer local content (own emphasis).That is, according to the report, they first globalised, and then attempted to achieve localisation later, in a sequential strategy.

This interpretation of the industrial policy literature on China betrays a lack of understanding of China’s hugely successful industrial policy, in particular in the Information and Communications Technology (ICT) sector, while even the Vietnamese analogy is also flawed.

As highlighted by Dieter Ernst while comparing the development of India and China’s electronics industries, when China liberalised ITA-1 tariffs in 2013, it was already the third largest global exporter and fourth largest importer of ITA products.

Having assiduously built up its national electronics firms over decades under a combination of strategic policies aimed at domestic market protection and expansion, direct and indirect support of national champions and technological upgradation, by then, China was a leading manufacturer and trader of ICT products. It was thus deeply engaged in electronics GVCs prior to joining the ITA-1and also before having any FTAs.

Contrary to what the ICRIER Report claims, China did not expand the scale of exports without first enabling its electronics firms to expand production by protecting its markets and promoting its national firms. As shown by Keun Lee, Huawei’s transformation from a firm making and selling digital switch systems in rural areas to one competing with MNCs and JVs and becoming the largest digital switch supplier in China happened by 1998, way before China began ITA-1 tariff cuts in 2003.

Huawei achieved this through the Chinese government’s support as exemplified by its “buy local” policy, imposition of tariffs on imported telecommunications equipment, and preferential loans from state-owned banks. However, the report has chosen to ignore China’s earlier policy trajectory and has focussed mainly on policies since the late 2000s.

The Report’s comparison of Indian electronics industry to Vietnam’s is also problematic. Firstly, Vietnam is more comparable with economies like Thailand or Malaysia, whose policymakers were ‘compelled’ to globalise earlier on in their development trajectory to complement scale and competition in their small domestic markets.

Such countries’ electronics industry development paths have been unlike those of larger economies like China or even of the neoliberal stronghold, the US, which have historically used export market demand for generating additional scale mostly after their well-supported national companies have achieved scale in their large domestic markets(very often through guaranteed domestic demand from government procurement of national products).

Even so, note that Vietnam had started the ITA-1 tariff reductions only in October 2008. The latter was completed only by 1 January 2014, a decade after India’s. India had completed ITA-1 tariff elimination by January 2005.

Secondly, Vietnam is not known to have developed significant software capabilities like India or China, which makes it a bad choice for comparison, as the new digitalisation wave opens up unique technological leapfrogging possibilities for India.

Way forward for India’s electronics industry

After a quarter century of globalisation in the electronics industry, we must not allow ourselves to be fooled yet again by the ‘mantra’ that boosting electronics exports to the exclusion of increasing domestic value addition will eventually offer the scale necessary to build up a domestic supplier ecosystem. The ICRIER Report, with its narrow focus on export volumes in mature products throws critical issues related to technological sovereignty out of the window.

Based on cross-country comparative experiences and firm-level studies, neo-Schumpeterian economics and innovation literature clearly show how technological progress is path dependent and cumulative, and involves capabilities built up through learning-by-doing (not learning-by-trading) and knowledge accumulation.

Protection from duty-free imports need to be maintained for a fixed period to allow learning-by-doing and to generate the domestic demand required to achieve economies of scale in domestic production. Simultaneously, ongoing policy efforts to improve the design and implementation of policies to increase their cohesiveness and effectiveness in increasing domestic value addition, by moving away from assembly towards domestic manufacturing, must continue.

Simultaneously, state support for the scaling up of R&D-intensive indigenous companies in both final products and advanced electronics parts and components production is critical. The state must share the risks in the development of advanced technologies, including through public procurement for innovation, as most technologically advanced nations have done and continue to do.

The digitalisation of the economy will boost the demand for electronics items manifold, as they are the backbone of all digital devices and digital equipment. Firms from countries that have made technological advances based on continuous R&D investments with state support, will keep building on their accumulated national capabilities to continuously create first mover advantages in new niche digital markets with high profit margins, with direct and indirect support from their governments.

Without building up innovative capabilities in a range of critical technologies indigenously, India will continue to find itself in a constant catching-up game in mature products/technologies, which will offer only minimal value addition.

Recent firm-level innovation research involving Samsung, Huawei, etc. suggests that forging a technological trajectory different from that of leading incumbents is often what helps firms from latecomer countries to compete effectively through leapfrogging and to catch-up with/overtake leaders.

India’s policies for the electronics industry must ingeniously build up synergies domestically between the design, engineering and software skills that have accumulated with state support over several decades.

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(The author is an economist based in Delhi. She would like to acknowledge the comments received from PVG Menon, Smita Purushottam and Anirban Dasgupta on a different version of this article. However, the author is solely responsible for the views expressed here.)