Semi-conductors and Ricardo

Hello dear reader,

Unlike last week, I might have something interesting to share with you today.

But before that, let me start with some incidents that happened this past week to build up to the moment.

My girlfriend and I were cleaning my book shelf. Let's just say the shelf got some light for the first time in years. Anyway that's beside the point.

I came across an old book of mine called ‘The Great Economists’ by Linda Yueh. Great book. Highly recommend. The book has 12 essays, each about one economist and their ideas. And the book does not discriminate. From Adam Smith to Marx and Keynes to Hayek.

It is one of the early books that I picked up when I started getting interested in economics. The second chapter is about a guy called David Ricardo. What did he do? Let's come to that in a bit.

In other news, I was listening to the seen and the unseen podcast, like one usually does. And this week’s guests were Pranay Kotasthane , the co-author of the absolutely brilliant newsletter

Anticipating the Unintended

and Abhiram Manchi. They have written a new book called “When the Chips Are Down: A Deep Dive into a Global Crisis” on semi-conductors and their impact on geopolitics.

The discussion was interesting to the say the least. I did not care much for semi-conductors initially but the episode got me hooked. The semi-conductor industry serves as perfect study material to learn about various aspects of economics and geopolitics. The episode itself can be a great place to start.

If I were to transcribe the entire 3.5 hours discussion, build a word counter or create a word cloud after removing the names of people/ countries (obviously excluding the word ‘semi-conductor’ and stopwords), I suspect two words would emerge prominently. Two words, something our friend David Ricardo made familiar: Comparative Advantage. That is what we are discussing today. This is not anything novel, I mean, Ricardo published his work in the year 1817. But these concepts are ever-relevant and its useful to always brush up the basics and be informed.

Before I try to explain comparative advantage, another term that the reader must familiarise herself is trade deficit/ surplus. When country ‘A’ is buying more stuff from country ‘B’ than it is selling to, it means, country ‘A’ has a trade deficit with ‘B’ and country ‘B’ has trade surplus with ‘A’.

Before Ricardo’s time, when mercantilism (read 18th Century Britain) reigned supreme, it was believed that a country must have a trade surplus with every country that it was trading to. It was at this time when works on free trade and globalisation became increasingly popular. Ricardo’s theory of comparative advantage is one such work which helped the world to globalise and thereby increase the scope of even smaller countries to be part of global supply chains.

Ricardo’s theory of comparative advantage is simple - each country should produce and export what it is relatively least bad at and import other things from other countries. As Yueh puts it - it is in the interests of every country to specialise in terms of what it produces and trade for what it no longer produces as much of. All countries trade globally as international trade increase efficiency for an economy as well as consumption for its people.

It is crazy how this works in the real world. Take the semi-conductor industry for example. The global supply chain is extremely complex such that the mobile / laptop that you are reading this post is made possible because of collaboration from 17 countries (from your chip architecture design to fabrication to assembly and all other raw materials that go into it). This is why globalisation is great. A small country like Taiwan is at the thick of the global semi-conductor supply chain because it was able to specialise on certain things and integrate itself.

Pranay and Abhiram also shared some history lessons in the podcast. One was quite interesting. In the 80s, Japan due to the knowledge transfer and consistent exposure to global markets, became an important player in the semi-conductor supply chain. They innovated and dumped their cheaper and more efficient memory chips into the market. The big bosses in the USA did not like it. And as always money chases power and vice versa. The big bosses persuaded the supposedly ‘free-market’ republican, Ronald Reagan to impose restrictions on Japanese memory chips.

But the invisible hand of the free market works in interestingly funny ways. Another country saw the space for cheaper and efficient memory chips. It specialised on that specific area and integrated itself to the global supply chain- this was South Korea. The big bosses realised that producing memory chips was not something that they are relatively least bad at and that they did not have a comparative advantage. They instead pivoted to other kinds of semi-conductor chips. Supply chains become more efficient. Again, globalisation is great.

As I write this post, I can imagine few of you readers shouting ‘China’ and ‘National Security’ at your screen. I acknowledge that. There are some ‘rogue’ nations that try to disrupt the global supply chain. Take the covid lockdowns for example, dependence on China became a big pain point for all major players. That is why you never put all of your eggs in one basket. Does not mean globalisation is wrong?. Take the semi-conductor industry, if China invades Taiwan and makes the biggest manufacturer a proxy for the Chinese state, I would not imagine that the whole semi-conductor comes to a halt and stays there. Even though there might be a huge impact in the short term, markets are resilient in the long run. It is not in any country’s long term interest to disrupt the global supply chains with force.

Also, another argument is that even if each an every country decides they will develop indigenous capabilities, it will not be able to scale innovation. I mean, after spending so much money to innovate and manufacture, who will you sell it to? The government and defence can only buy so much.

It is kind of a vicious cycle that we have already seen happen in India.

Let’s come to India now. Our first prime minister Nehru is at the receiving end of so many abuses for various unnecessary things from people online even today. It is so much so that it has become a meme. Even if a bridge breaks down somewhere in India in 2023, it is because of J Nehru, the womaniser, even though he died in the 60s. It is not to say that Nehru’s governments did not make bad choices. One such important ‘bad’ choice is when he decided that we will make everything ourselves, more specifically, the government will make everything. It is not fair of me to criticise the founders of the country without acknowledging that the prevailing trend of newly independent countries at that time was to close off global markets. But, now in hindsight, we know that markets and globalisation is the way to prosperity.

However, Nehru was not around when semi-conductors started becoming critical to how we live our lives. But his ghost(read looming state, import restrictions etc) still remains. Pranay also mentioned India’s attempts to open two new public sector companies (what else would we do?) to get involved in semi-conductor manufacturing. But it is proven fact that government institutions will not, cannot be competitive. Scaling innovation and efficiency is possible only because of free markets and competition.

In other aspects of technology, after we liberalised our markets in the 90s, thanks to the great Narasimha Rao and Manmohan Singh, Indian companies understood comparative advantage and specialised on human capital.

Nehru’s ghost still remains with us, especially with our current government. Even though political parties abuse each other in India, their policies towards state and market remains more or less the same. As Arun Shourie famously said, BJP = Congress + Cow. When we hear words like import substitution and increased tariffs, we get a sense of how right Arun Shourie was.

Arc of history bends towards justice and prosperity. India, for the most part, is trying to integrate itself into the global supply chains. We must leverage our comparative advantage of human capital and leverage globalisation to the fullest of its potential. Remember, India still has about 20% of its people living below the poverty line and mind you the poverty line limit is about Rs 27,000 per year. This is the state even after pulling close to 270 million people out poverty since the 90s due to globalisation and liberalisation. Do with this information what you will.

Reccos for the week:

1. The Seen and the Unseen- Episode 358: The Semiconductor Wars

2. When the Chips Are Down: A Deep Dive into a Global Crisis

3. Perplexity, an LLM. Aravind Srinivas from USA is one of the co-founders. I believe he is from Chennai and did his engineering from IIT Madras.

Also watch Kuzhangal on Sony Liv. Don’t stop there. Read about the movie once you’ve watched it. Watch interviews of people discussing it. It is great.

Until next time folks.