Clusters, not champions

Recently, Nokia decided to shut its factory in Sriperumbudur, following a tax dispute with the Indian government and the loss of orders from Microsoft, who took over most of Nokia’s cellphone business (in fact, all of it apart from the Sriperumbudur factory). Consequently, it has had to let go of most of its workers in its plant. The results, as Mint has reported here, are not pretty at all. People who worked for years at Nokia assembling phones have suddenly found that in the absence of Nokia, there is no comparable employer in the Sriperumbudur area. There is little else in terms of mobile phone manufacturing in India – most Indian companies get their phones manufactured abroad. Only this April did MicroMax start manufacturing phones in India – in Rudraprayag, far far away from Sriperumbudur.

Around the same time that Nokia was shutting down its factory in Sriperumbudur, Yahoo! decided to shut down its software engineering operations in Bangalore. About 600 employees got sacked (with severance payouts), while a few top performers were given the option of either relocating to its California headquarters or exiting the company with an even better severance payout. In the days that have followed, there has been a massive scramble for the now ex Yahoos among software companies in India. Apart from those that are yet to make up their mind, most ex Yahoos are gainfully employed, most of them in Bangalore.

The reason for the differential outcomes in the above two cases has to do with geography. Nokia’s plant in Sriperumbudur operated in an island – in a place where there was little else in the way of mobile manufacturing units. Thus, employees of the plant (who were well paid, as per the report), came to depend wholly on Nokia for their livelihoods. It something happened to Nokia, as it did, or if for some reason their relationship with their employer or boss soured, they had nowhere to go. Even when the plant was fully functional and successful, employees of the plant were effectively “locked in” to their employers and thus had little choice in terms of their careers.

Yahoo!, on the other hand, had (and has; operations have not ceased yet) its office in Bangalore, which has emerged as an excellent hub for software engineering services in India. From the time Texas Instruments first set up its office in the city over thirty years back (apart from the weather, a guiding factor for that decision was the availability of engineering talent in Bangalore, thanks to the presence of defence PSUs in the city), Bangalore has only grown as a market for techies. Thus, there is a large number of IT companies that has made Bangalore its home, and there is now a significant market for techies of all levels and skills in the city. Thus, when Yahoo! decided to shut its factory, there was little problem in absorbing the now surplus employees.

The difference between Sriperumbudur and Bangalore was that Bangalore grew organically as an IT hub – companies invested in the city because it made economic sense for them to invest there, in terms of the ecosystem, and upward and downward linkages available in the city. Nokia, on the other hand, was “parachuted” into Sriperumbudur. The Mint story mentions that the Nokia factory was situated there after some kind of a bidding war between various states, and was essentially a political decision and not a business decision made by Nokia. Nokia was followed there by its suppliers (who are also facing an uncertain future now) but that was the end of it – there was no further growth in the mobile manufacturing ecosystem in the Sriperumbudur area. Thus when the one company that the tiny ecosystem there got dependent on decided to shut shop, the consequences were disastrous.

There are several policy lessons that can be drawn out of the above contrast. The first, and most important, lesson is that companies should not be “parachuted” into areas chosen by the government (Jane Jacobs has an excellent treatment of this in her book Cities and the Wealth of Nations). Instead, investment should happen “organically”, by means of decisions that make business sense to the investor without relying on artificial sweeteners such as tax breaks (this might mean that no investment might happen in certain areas, but that only means that such areas are overpopulated and people from there should move to areas where investment happens).

As a corollary of the above lessons, we need land acquisition laws that are friendly to both investors and landowners – the current law passed last year is friendly to neither, but simply enhances the power of the government. The key to the building of large industrial clusters (especially in heavy manufacturing industries that the current government plans to promote) is that companies will want to be situated close to other similar companies, or companies that form an upward or downward linkage. This means the company should have the ability to set up shop close to the existing cluster, and that means being able to purchase the land at a “reasonable” (both to the company and the land owner) price. A land acquisition law which empowers the government at the cost of the transacting parties prevents such organic expansion from taking place.

Thirdly, governments should stop promoting “champions”. The assumption is that once you have a “champion” of a particular sector set up shop in a particular area, it will automatically lead to an ecosystem for that sector in the area. As the Nokia story demonstrates, this is not necessarily the case. What the government should do is instead simply be an enabler for clusters, and stop looking for “champions” to establish such clusters. In fact, it is not necessary for a big investment by an existing company for a cluster to develop, and this needs to be recognised.

Conventional wisdom regarding the success of the software engineering industry in India is that it succeeded “in spite of” rather than “because of” the government – being a new sector it was lightly regulated that resulted in its rapid growth and success. While the contribution of the government in the overall success of the industry might be debated, what is clear is that lack of government intervention has helped the industry to build around a few “clusters”, and that has only made the industry stronger.

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