A Lost Comparative Advantage? India's Electronic Hardware Industry

Globalisation has fundamentally been a centralizing tendency, drawing disparate economies and sectors into the vortex of a world controlled by a few decision makers. It replicates this centralization in economies which it integrates into the world system, creating strong domestic interests that support the case for an open economy and a pro-market strategy . The sources of inequality which change as a result of rising globalization within developing countries cannot be identified the same way that macroeconomists have historically identified, in respect to the sources of growth, as a result from trade liberalization.

While the pro-market reforms pursued in India during the early 1990s were not specifically directed at employment creation; 'the stated expectation' of policy makers over this period was that liberalizing markets easing the conditions for entry and operation of foreign investors and encouraging exports especially in agriculture would all contribute to generating more employment. In a paper written a few years ago, I highlighted an inherent flaw with this stated expectation of neo liberal advocates; by focusing my study on identifying the link between public expenditure, wage inequality and growth of employment opportunities across sectors within rural-urban areas during the 1990s. The incorporation of indicators like employment elasticity and state per capita output employed in the paper offered some useful insights pointing towards a forward looking metric that is often ignored by policymakers and the state, ultimately leading to the rise in rural-urban social inequalities.

In this article, we analyze the effects of India's half-baked industrial liberalization policy measures pursued since the early 1990s by studying the shift in focus towards the IT software industry, causing a blowback to the growing electronics hardware industry then, resulting in an irreversible collateral damage. India saw a domestic demand for electronics worth $125 billion in 2014 where 65 per cent of this demand is imported as of today. The import bill for electronics is estimated to reach $300 billion by 2020, surpassing the oil import bill.

With a flourishing service sector in the ICT segment, as well as an explosive and recurring household consumer demand for electronics, it is alarming that India's domestic production has been unable to tap into this gold mine and is dependent on imports to meet 65 per cent of our electronic needs. In fact, electronic imports have already exceeded the bill of gold import in 2015 (the second highest import bill in 2014 after oil) for the first time. Attempts by the government to address this in the form of the New Electronics Policy 2012, the New Manufacturing Policy 2011 and its most advertised 'Make in India' campaign seem optimistic but highly inadequate to address this alarming trend.

Demand in this rapidly growing sector is currently growing at a compound annual growth rate (CAGR) of 24.4 per cent and it is unlikely to face any dampening obstacles before 2020. The government is aiming to push for greater supply currently estimated to be growing at just 16 per cent. Such a growing gulf is leading India into an unsustainable trade deficit. Albeit, the adequacy and effectiveness of these measures in bridging the demand-supply gap is questionable, a question that becomes pertinent to raise at this juncture is how did we end up with such a seemingly insuperable demand-supply gap in the electronic hardware sector at the first place?

Domestic manufacturing of electronics in India is only around $40 bn. As business expansion in manufacturing sector often has strong backward-forward growth linkages, the assumption has been that the demand shall create its own supply considering the profitability of the hardware sector with a rising software industry. The growth levels in the IT software industry and hardware industry in India were equally low and thus, pretty similar till the 1990s.

In 1979, the government opened up the hardware industry to the private sector with restrictions. Import substitution gave way to technological development and components from abroad to bridge the technological gap. Encouragement was given to exports of electronics which grew at a CAGR of 19.37 per cent during 1981-1992 with hardware constituting the bulk of the share of exports. However, this growing trend began to stagnate with the advent of the 1986 Computer Software Policy which for the first time acknowledged the importance of software development and formulated policy incentives accordingly.

This was mainly a response to global demand for computers that had increased due to the arrival of the desktop computer and its diffusion during the 80s which saw the introduction of the computer in multiple areas such as government administration, education, security, research, etc. in advanced countries such as the United States. These countries required customized software and the Indian government recognized this as a lucrative opportunity for increasing its export competitiveness in this sector. Moreover, an expanding skilled labor force available at one-tenth the global labor cost could be absorbed in the software which gave us an edge as a cheap software service provider in the global market.

Domestic demand for computers in India also began to grow in the 80s, the production of which was not enough and the government was forced to allow duty-free imports of inputs to encourage the software industry. Through the 1986 Computer Software Policy, free import of licensed software packages was allowed and quick approvals for joint ventures with international software entities was facilitated.

Impact of Liberalization on Manufacturing
In the economic reforms of 1991, the finance ministry consciously chose software over hardware for a thrust in exports and initiated measures to remove entry barriers for foreign firms and technology. This was a major blow to the electronic hardware manufacturing base and the production of hardware which grew at 24.2 per cent CAGR during 1981-1990 fell to 14.17 per cent during 1991-2000. Hardware also slumped to a share of 11 per cent in electronic exports from India by 1999, while share of software exports doubled by the end of the decade. (Figure 1)

A conscious policy digression and neglect shown towards the hardware sector, allowing duty-free imports of equipment to give impetus to software exports resulted in a widening of the gap between domestic demand requirements and domestic industrial capability. It also led to an uneven distribution of technical workforce, away from hardware towards the software sector. The electronics hardware industry, which reaped the early benefits of an initial attempt by the government to de-license and free up production during the 80s (under the Rajiv Gandhi era), began to lose momentum in the 90s and has been rendered incapable of regaining its comparative advantage till date.

While studying the impact of trade and partial industrial liberalization, privatization on the wage structure and employment growth rates, it is difficult to find evidence in the literature about a generalizable relationship between globalisation and growth of employment in developing countries as a whole. The relationship is dynamic and changeable, reflecting particular interactions in each economy between the external facets of globalisation (e.g. shrinking economic distance, greater trade or the spread of international production) that apply to the economy and internal factors that affect its employment response.

The liberalization policies followed in India greatly altered the product structure of electronics manufacturing by offering inverted incentives to the private sector to divert investment from more capital and R&D intensive areas to items which offered quick returns. This undermined the development of the technological capability of the sector, curbed manufacturing of inputs and intermediates which resulted in a lack of domestic linkages which plagues the sector till today.
The Blow: India's Tryst with the Information Technology Agreement (ITA)

The signing of the Information Technology Agreement (ITA) in a bid to "open-up" the economy killed what was left of the nascent electronics manufacturing industry in the 90s. The ITA is a plurilateral trade agreement of the WTO which India became a party to in 1997 along with 29 other countries. The ITA required that member countries reduce their tariffs and duties on imports to zero on a Most-Favoured Nations (MFN) basis to all WTO members

The ITA agreement had seriously negative consequences on India's fledgling domestic electronics manufacturing industry. Our manufacturing exports experienced a decline immediately after signing the ITA agreement in 1997. Exports fell from US$ 3.25 million in 1997 to US$ 2.6 million in 1998. As India subsequently phased out tariffs on electronic products, India's ITA imports grew by 18 per cent annually from 1997-2000 and doubled in the years 2000-05. The situation has spiraled out of control today with two-thirds of India's domestic electronics demand being met through imports.

Interestingly, the objectives of the ITA was to promote greater diffusion of Information, Communication and Technology (ICT) goods amongst countries, especially developing ones. But diffusion of ICT goods for the Indian case, came at a cost of killing the domestic manufacturing (cap)abilities. India serves as a classic example where production of IT goods took a backseat while IT goods diffused within the economy at a staggering pace. And while the government today seeks to push for a strong Make in India image in redefining India's manufacturing potential across most sectors it would be prudent for the current regime to revisit and avoid past policy mistakes.

With inputs from Mehak Malhotra