The higher the capital intensity the fewer the number of companies an industry is able to support.
How many producers can an industry support? This is a very old question in economics, which gains salience once again after the announcement by Ford Motors that it will stop production in India.
I should add here that I used the Ford Fiesta for 12 years from 2008–two cars in succession–and found it to be an excellent vehicle. Then, for some reason, Ford fiddled with the model making it smaller and I stopped buying.
Anyway, several other auto companies have also stopped operating in India over the last decade. But without going into the specifics of each exit, it is worth enquiring into the larger question: the relationship between the capital intensity of an industry and the number of firms it can support.
The two variables appear to be negatively correlated. Thus, the higher the capital intensity the fewer the number of firms an industry is able to support. It doesn’t matter whether we are talking of financial capital or, in these days of internet-based businesses, human capital.
The railways are a perfect example of where there is generally a monopoly over routes because of the high capital intensity. Attempts, led by the British in the 1990’s, to introduce competition on routes have had very limited success. The industry is reverting to mean now, namely, route monopolies.
But, on the other hand, in civil aviation despite the high capital intensity, several airlines compete for traffic. Predictably, only a handful make profits. So there too there is periodic consolidation. Most international direct routes are government-induced duopolies.
You can see the same thing happening with a host of other industries like steel, oil, gas, telecom etc. Indeed, when you see the amount and value of human capital engaged in IT–Facebook, Google, etc–you will find the same thing.
This tendency creates a problem for competition in two ways: because of an outright monopoly which raises prices by restricting output–Indian Railways do the opposite, by the way–or a small oligopoly with three or four firms that can collude and fix prices.
This is classic cartelisation.
The policy issue
This is the policy problem that India has to solve, namely, the tension between capital intensity and competition on the one hand and price rigging on the other. I am not aware of any systematic effort having been made in this direction.
Before 1991 when India had central planning and industrial licensing as an instrument of resource allocation at the macro and micro level respectively, it generally allowed 3-5 firms to compete in capital-intensive industries. But given the dominance of the public sector there was no competition worth the name. Everyone was a price taker.
Steel was an excellent example of this. The private sector, more efficient than the public, made profits on the back of the latter’s high prices induced by its inefficiencies.
So limiting the number of firms to 3-5 wasn’t such a bad practice. What was bad was government ownership of 80-90 percent of the industry’s output. This made the whole industry sclerotic.
A special problem, however, arises when an industry is both capital intensive as well as B2C. This is what has happened in civil aviation, autos and telecom.
Freedom of entry led to excessive and unhealthy competition but now as competition reduces, all three are increasing prices. The same thing is happening in B2B industries also.
Over the next few years, therefore, all these businesses will turn profitable at the expense of the consumer. One must hope that those who regulate these businesses will act wisely and not intervene badly.