Adopt Krugman

The Nobel laureate’s trade theory can change India’s business paradigm.

My aim was that i would produce a certain volume of cars and create a very low-cost, very low-break-even point plant that a young entrepreneur could buy. A bunch of entrepreneurs across the country could establish such assembly operations and Tata Motors would train their people, oversee their quality assurance and they would become satellite assembly operations for us. It would be satisfying if the small car created 10-15 satellite groups of young engineers who could get together and do a business. They would never otherwise be able to get into the assembly of cars,” Ratan Tata had told a newspaper on January 10, 2008, describing his business plan for the Rs 1-lakh Nano.

Glocal Giants: Krugmans Nobel-winning work provides the rationale for Indian firms to go global on local strengths
Glocal Giants
By design or default, Tata’s business plan for the Rs 1-lakh car has made the Nano a perfect candidate for a Paul Krugman success story. The American economist and popular columnist won the Nobel Prize for Economics in 2008 for his trade theory, which explains trade between countries endowed with similar resources. It also explains trade in similar products. Trade between Italy and Germany, for instance, in Porsches and Ferraris, or between the US and Canada in Bombardier planes and Boeings had remained unexplained until Krugman, 55,came out with his trade theory in 1979-80. The Nobel-winning work showed that producers make and export more and more of those products that have large home markets. That’s because spread over higher volumes, costs come down, raising cost competitiveness (economies of scale).

Why is the Nano a potential Krugman success story? Because there are few markets in the world bigger than India for the Nano. Indians buy a million small cars a year. Tata Motors hopes to sell 500,000 Nanos a year by 2012. The cost of making a Nano, therefore, will progressively decline as Tata Motors sells more and more of the small car here. A point will then come, when the cost per car will have plunged sufficiently to make the Nano globally competitive (if it isn’t already).

Of what use is Krugman’s work to Indian businesses? Indian companies can leverage the new markets emerging here to build new industries. For example, India’s imports of power and telecom equipment total $40 billion (Rs 1,96,000 crore) a year. This large market can easily sustain indigenous production, but India has made it extremely difficult for the domestic industry to compete with foreign ones by withdrawing all protection. Says Nagesh Kumar, Director, Research and Information Systems, a trade think tank in the Capital: “Five years of protection will enable Indian businesses build scale and competitiveness.” Ship-building and aerospace are other industries that can benefit from Krugman’s formula.

Nobel lessons

Krugman’s thesis:
Producers leverage huge domestic market followed by export markets to progressively lower costs.
Example from India: Tata Motors’ plans for the Nano.

Krugman’s thesis: Producers converge close to a large home market.
Example from India: Exports of the Indian gems and jewellery industry grew 23 per cent in 2007-08 over the previous year, while India’s consumption is growing at the rate of 25 per cent a year. More than 10,000 diamond units have converged in Surat, where 80 per cent of the diamonds processed in India are cut and polished.

Krugman’s Thesis: Policymakers must nurture infant industries capable of building global scale by tapping the home and export markets.
Example from India: Policy incentives to sectors such as power, telecom equipment and aerospace can help

Krugman’s next step was to show that lots of producers converge to locate their manufacturing units where there is a large market. By sharing infrastructure and overhead expenses, producers located in a cluster can prune costs and raise competitiveness using the economies of scale.

This can be handy in the context of the pressing skills crunch. Companies that are losing their trained manpower to poachers end up sinking the costs of training the lost workers. Companies can avoid such losses by jointly training pools of workers that they can all hire from. “Joint training of workers by companies can release positive externalities for Indian business in line with Krugman’s teachings,” says Bibek Debroy, Professor, Centre for Policy Research & IMI. Agrees Biswajit Dhar, Head of the Centre of WTO Studies, Indian Institute of Foreign Trade: “Small and medium enterprises must keep in mind that the cluster approach is very important for industrial development in Krugman approach.”