Outsourcing Information Technology And India S Economic Development
Outsourcing Information Technology and India’s Economic Development
India, with its 3.28 million square kilometer landmass and a population of over one billion, is one of the largest countries in the world, in terms of both size and human resources. Since it became independent in 1947, India’s economic policy can be divided into two phases – import substitution and economic liberalization. Unlike lot of other Asian countries, India’s development has not been so obvious until recently. However, in little over a decade, India became the world’s “think-tank” and the hub for international outsourcing.
Outsourcing generally means services previously provided in-house are bought in from third parties; it is categorized into two on the basis of location of the provider. If the contract is given to a third party located within the national border, it is called “onshoring,” and if the service provider is located elsewhere, it is referred to as “offshoring” (Datar, 10)
As the world’s most important offshoring location, the Indian subcontinent commands over 44% of the global market for IT and IT based business processes, or in abbreviation BPO (Schaaf, 1). How did a country whose success in both exports and industrialization have been modest, suddenly achieve prominence and global competitiveness in a leading edge sector? The issue is even more puzzling if one keeps in mind that conventional indicators of IT penetration, such as personal computers per thousand population, internet subscribers, telephone connections, scientists and engineers per million, all make India look decidedly mediocre. The country’s telecommunications infrastructure remains weak, and few Indians have access to a PC, let alone to the Internet. As if it’s not enough, India’s ranking in the United Nations Development Program’s (UNDP’s) new Technology Achievement Index (TAI) is a modest 63, not exactly indicative of a country that has achieved a buzz in the extremely competitive and sophisticated global IT markets (Kapur, 92).
Is India becoming to global service trade what China has become to global manufacturing trade?
This paper is an attempt to understand the causes and effects of outsourcing information technology (IT) to India. It will discuss the characteristics of Indian economy that draws international businesses and the consequences it has on the Indian economy. Challenges faced by the Indian outsourcing firms will also be discussed.
India – Two Phases of Development
Like most of the countries emerging from colonialism, India initially followed a policy of import-substitution, aiming to be self-sufficient. This policy however, did not do much good to the Indian economy. India fell behind while the South-East Asian countries witnessed phenomenal growth. (Kochar, 27).
The Indian economy started undergoing major changes starting in 1980s, and reforms accelerated in the early 90s. The key features of reforms in the 1980s were (i) import liberalization—especially of capital goods and intermediate inputs, (ii) and extension of export incentives through the tax system (Kochar, 12). The reforms of the 1990s further opened up the economy (Kochar, 12). Import licensing was abolished and progressive reduction of non-tariff barriers were put in place and domestic producers were granted more freedom. Liberalization was witnessed in the form of freer entrance to domestic and foreign private banks, opening up of the insurance sector. These reforms were reflected in sharp acceleration of the growth rate: the annual average rate of growth of GDP per worker increased from 0.69 percent in the 1970s to 3.9 and 3.3 percent, respectively in the 1980s and 1990s (Kochar, 12).
Causes for Outsourcing – Why India?
It is a known fact that India is the most important location for IT services and business process outsourcing. The country commands well over 65% of the global IT-sector offshoring market and there is no threat for India’s position in the foreseeable future (Lanzeni, 4). Six years back, the Indian IT services earned a measly $6.2 billion in export revenue, by 2010; the industry is expected to generate export revenues of $60 billion (NASSCOM McKinsey Report 2005, 2). Why is India getting all these billion dollar deals despite its humiliating infrastructure, lengthy legal processes and poor transportation network? This puzzle can be answered when the country’s comparative advantages are studied. Some of the major reasons behind India’s success in the industry are:
The most decisive advantage is India’s huge pool of human resources. India’s current population is well over one billion, and it is expected that India’s labor supply would increase by 250 million by 2020. It is an addition of 15 million people every year (Schaaf, 3).
Despite India’s high illiteracy rate, by the late 1990s India was producing about 65,000 engineers and 95,000 diploma-holders annually in engineering and technology through a large network of public and private colleges (Kapur, 97). The system was producing nearly 100,000 IT professionals annually, many through private institutes, and the figure is projected to increase to half a million by 2006 (Kapur, 97).
Due to this large pool of skilled laborers, the Indian engineers and programmers don’t earn much; their annual pay is not even close to their American counterparts. The annual income of an Indian IT employee with one or two years of experience is only about $ 8000, and the inexperienced ones earn even less (Schaaf, 3). However, the big multinationals don’t base their decisions on pay alone; they have to take into consideration all the cost they have to incur. It includes expenses incurred on establishment of new workplace, development of telecommunication network, management cost, and other miscellaneous costs. Thanks to the wage differential, there is still room for savings (Schaaf, 4).
However, this is not enough to attract off-shoring to India. When we compare the different off-shoring locations, we have to take into account the affects of tax policies, education standard, and infrastructure variation. After taking all these into consideration, India still offers the best package. One Fortune 500 firm that consolidated several fulfillment operations to Bangalore reported that the overall cost savings were 80 percent (Arora, 14). These represent significant dollar savings.
Education, Skilled Workforce and Global Recognition:
For a poor country, India spends far more resources on higher education than on primary education. For example, in 2000, India spent 86 percent of per capita GDP on each student in tertiary education in 2000 while it spent 14 percent of per capita GDP per student in primary education. By contrast, Thailand spent 33 percent and China 10.7 percent of per capita GDP per student in tertiary education in 2000, while they spent 16.5 percent and 12.1 percent of per capita GDP respectively per student in primary education (Kochar, 5). The seven IITs (Indian Institute of technology) have a reputation of producing engineers and programmers of top caliber, and all of these institutions are located in high-tech clusters, hence catching the attention of the big clients.
India not only has a large number of skilled workforce, but the IT companies strive hard for quality. This is reflected by the large number of Indian companies recognized internationally for their high quality work standard. Out of the 80 software companies in the world with a CMM 5 rating in 2003, 60 came from India (Schaaf, 5). CMM is a standard for measuring quality for software development and CMM 5 is the highest rating.
Unlike other sectors of the economy, state intervention had been absent in the IT development. India’s IT minister, Pramod Mahajan, once made a clever remark that India is a leader in “IT and beauty contests, the two areas that the government has stayed out of” (Kapur, 103). This policy of non-intervention is one of the reasons why India is able to attract lot of clients. The sector is driven by private firms that stay on the edge of technological know-how by competing with the big players at the global level. The government not only stayed out of IT industry, it also adopted the industry as one of the top five priority industries. A separate Ministry of Information Technology has also been set up to expedite the swift approval and implementation of IT projects and to streamline the regulatory process (Why outsource to India, 4).
One of the greatest advancement in IT came with the establishment of the first STPI in 1989. Software technological parks offer world-class infrastructure and various incentives and concessions to encourage foreign investment and to promote software development in India. 100% foreign ownership has been permitted in the STPs and these parks were granted tax holiday until the year 2010 (Why outsource to India, 4). By July 2004 a total of 40 STPs had been set up, and 20 more are planned to be established by 2012. In March 2004, the STPs were home to a total of 4,644 companies (Schaaf, 6). More than three-quarters of them export software products. The development of such STPs provided a great deal of benefits (Schaaf, 6). Like the Silicon Valley, most of the Indian IT companies are concentrated in Bangalore. This concentration gives them a number of advantages – plenty of skilled workers are always available ready to be utilized, and knowledge spillovers keep them on the cutting-edge of technology at all times.
Keeping the importance of IT industry for growth of the India’s economy, the Indian Parliament passed the IT Act in May 2000. The IT Bill brings E-commerce within the purview of law and accords stringent punishments to “cyber criminals”. With this law, India has joined a select band of 12 nations that have cyber laws (Why outsource to India, 4).
The strength of a united voice is one of the key success factors in business. Unlike other sectors in India, the National Association of Software and Service Companies has been very successful in lobbying the government. All software companies in India, both domestic and foreign are representative by this association and this gives the industry a unified voice, and it has been successful in promoting the sector’s interest. The seven fold strategies according to the organization’s website are:
• Partner with Government of India and State Governments in formulating IT policies and legislation. Partner with global stakeholders for promoting the industry in global markets.
• Strive for a thought leadership position and deliver world-class research and strategic inputs for the industry and its stakeholders.
• Encourage members to uphold world class quality standards.
• Strive to uphold Intellectual Property Rights of its members.
• Strengthen the brand equity of India as a premier global sourcing destination.
• Expand the quantity and quality of the talent pool in India.
• Continuous engagement with all member companies and stakeholders to devise strategies to achieve shared aspirations for the industry and the country.
The Diaspora Network and Confidence of Global Corporations
The Indian Diaspora also plays an important role in creating a link between the multinationals and the home country. More than 750 companies in Silicon Valley are led by Indian-Americans (Why outsource to India, 1). They have boosted the confidence of the foreign investors in India’s potential despite innumerable problems. Companies like Yahoo, HP and GE created establishments in Bangalore based solely on the confidence provided by the large number of Indians working for them domestically (Kapur, 100). A Diaspora network is important for building up the reputation for India, which is extremely important in sectors where knowledge is the key. The successful Indians in Silicon Valley appear to be influencing how the world views India.
Cultural and Historical Advantage:
Cultural and historical factors also played a major role in attracting the western clients, even though these factors are not so intentional and obvious.
India was under British occupation for more than two centuries, and exposure to British culture and language came in handy when outsourcing opportunities came by. In the 1950s, language policy became a divisive tool among the Indians, bringing the country to the brink of instability. The non Hindi speaking majority had the fear of being dominated by the northern Hindi speaking minority. As a measure to combat this problem, even though Hindi was made the national language, it was not to be imposed on the non-Hindi speaking mass, and English instead enjoyed the status of the national language. Today, more than 350 million Indians speak English, that is more English speaking population than US and UK combined (Crystal, 2). This is one of the primary reasons why India gets the lion’s share in off-shoring, despite stiff competition from China and Russia.
Before the economic liberalization of India in the 80s, the Indian government was very inhospitable towards foreign companies. The departure of IBM in the late 1970s and the protection of India’s hardware sector led to the development of software skills in a form of induced innovation (Athreye, 8). The very limitations, technological and cost, of hardware in India meant that developing software skills was the only way to overcome them. IBM’s departure paved the way for the introduction of minicomputers and microcomputers. Most of these new systems used the UNIX operating language and as it gained popularity world-wide, Indian programmers had an early learning advantage (Kapur, 5).
The demand for software engineers and programmers increased more than the relative supply in the USA, and as a result, foreign specialists were given special work visas. Between 1999 and 2000, 43% of the total H-1B visas were given to Indians; by the end of the year, there were 200,000 Indians under this visa classification (Schaaf, 6).
All these factors led to India becoming one of the major players in the Global IT business and most of the researchers in this field believe that India will not face much competition at least for a while. But before generalizing anything, let’s take a look at the consequences of IT outsourcing on the Indian economy.
Economic development often follows a sequence whereby the share of the agriculture sector in GDP declines progressively, with offsetting increases in the shares of the industry and service sectors. As an economy marches toward maturity, the share of industry in GDP stabilizes or contracts a little while that of services advances further. India’s economic transition, however, has been unusual. It appears to have skipped the industrialization phase and advanced immediately to a services sector-led economy (Kochar, 16). Instead of developing a manufacturing industry as it is dictated by its huge labor abundance, India’s emphasis on service sector has been notable. There are varying views about the pros and cons of the development of IT outsourcing, and some of the consequences are discussed below.
Service Sector Expansion:
With the change in economic policy in the 80s, India’s sectoral pattern evolved tremendously. Between 1980 and 2002, India’s share of services in value added went up from 37 percent to 49 percent, while its share of manufacturing in value added remained broadly unchanged at 16 percent, with the decline in agriculture mirroring the performance of services (Lanzeni, 8). The corresponding numbers for employment were 19 percent to 22 percent and 14 percent to 18 percent (Lanzeni, 8). India’s service sector now constitutes about 50% of GDP – compared with about 25% five decades ago (Lanzeni, 8)
However, this increase in service sector is not reflected in the size of its employment. India was falling well below other countries by a huge 17% in 2000. Gupta and Gordon noted that unlike other developing countries, India’s labor share in service has been rather flat instead of growing with income. The rise in value added without a corresponding increase in employment can be explained only by one factor – India’s labor productivity in service sector should have risen remarkably. Since 1980, software and information technology has been the leading development in the service sector.
Economies of Scale:
With the growing productivity of Indian service sector, especially in the field of IT development, the Indian managers and programmers gained experiences and expertise. This is reflected in their achievement of economies of scale – both in terms of internal and external.
The Indian outsourcing companies are now moving away from simple programming and straightforward IT-based programs to more complex projects that yield higher margin. They are climbing up the value chain, by providing quality services like consulting in accounting and finance (Schaaf, 1). More innovative companies are still taking more risks by trying out more processes that require special expertise. KPO (knowledge process outsourcing) is the acquisition of expert knowledge of Indian workers through IT-based tools. Concrete examples of KPO are – balance sheet analysis of small and medium-sized enterprises, and counseling by medical experts (NASSCOM).
The growth in IT is not restricted to national borders; Indian companies are setting up subsidiary offices in the USA and Europe to reach their western clients on a firsthand basis (Schaaf, 10). They are also buying small and medium sized companies to gain access to promising markets.
These developments are well reflected in the enormous increase in export of IT-based business processes. Export revenues from the BPO sector increased from US $2.5 billion in 2003 to $3.8 billion in 2004, it further went up beyond $5 billion in 2005. The revenue is estimated to reach 14 billion this year (Kapur, 103).
India is one of the most populated nations in the world, and three hundred million people continue to subsist on one dollar a day or less. Job creation and labor absorption are central to any economy, and it is especially critical for a country like India. The enormous boom in outsourcing is providing much needed job opportunities by alluring many high skilled workers to seek employment within the country, and it also dwindles down the negative effect of brain-drain (Kapur, 102).
The employment in outsourcing is increasing at a tremendous rate. In 2005, there were more than 700,000 experts working in the IT industry, which was a 25% increase from 2004. It is estimated that by the end of this year, they will be about 1.5 million people in this sector (Kapur, 103).
The Multinationals were attracted to outsource to India initially on the basis of availability of English educated cheap labor pool. As the MNCs move their operations into the country, they began to absorb a large number of English speaking high skilled workers. This demand has created incentives to achieve higher education as the potential benefits have increased. Sustained demand has resulted in the development of thousands of private degree and certificate programs throughout India (McDonald, 18).
The number of engineering degree holders alone has risen from 59,311 in 1997 to 141,646 in 2003 (McDonald, 18). More than half of the admitted students seek IT degrees, indicating the influence the sector has on education. The aggressive demand for this field of education led to the government establishing an entire sector of private education in IT with thousands of institutions throughout the country. The private companies are coming up with their own set of programs to fill the gap (McDonald, 19).
Growing Income Inequality:
However, the development of India as the locus for outsourcing is not only associated with benefits, there are many concerns at the same time. Critics argue that the excessive focus on the IT sector amplifies the income inequality between the rich and the poor. More than 70% of the Indian population is located in villages, and many of them even don’t have access to electricity and telephone, let alone computer and internet (Chandrashekhar, 9). The growing IT and BPO centers are located only in a handful of cities and this concentration creates an income breach between the people and different cities and states. Chandrashekhar reflects the skeptical view of effects of the IT industry, arguing that any benefits have been confined to urban elite, and that its growth has been based on cost advantages rather than deeper technological capabilities, making the continuation of growth doubtful.
Nevertheless, development of IT-sector facilitates diminishing the gender inequality. Participation rate of women in this sector is relatively high compared to other sectors of the economy (McDonald, 20).
Despite the fact that India currently is the number one spot for outsourcing, there are number of stumbling blocks that need to be cleared in order to gain maximum profit.
Increasing challenge from emerging markets:
India is not the only country with abundant English speaking, highly trained workers. Countries like Pakistan, Sri Lanka, and Bangladesh are coming up with their own outsourcing companies, modeled after the successful Indian pioneers. China and Philippines also pose an increasing threat. However, Russia and Eastern European countries are currently the strongest competitors against India. The principal market for Indian software exports is the USA, with a share of 67 percent, followed by Western Europe -21 percent and Japan – 2 percent (NASSCOM). Because of the minute distance, it is easier for the Western European nations to manage and supervise the operations if their outsourcing service providers are located in Europe. India might lose its European clients if Russia and the Eastern European nations change their policies making it favorable for the clients (Schaaf, 11).
Challenges are not only imposed by these nations. The big western IT service providers like IBM and EDS are increasingly establishing and expanding their developmental facilities in India, competing with the local companies both for foreign contracts and local workers (Schaaf, 9). This competition is driving up wages and squeezing margins. However, the expertise of the Indian companies is currently keeping them way ahead of their international competitors (Schaaf, 9).
The Indian companies are trying their hands at expansion too; they are looking for skilled workers from neighboring countries like Sri Lanka and Pakistan. One of the leading Indian companies – Infosys has more than 19,000 employees of 38 nationalities in 16 nations (Schaaf, 9).
The increase in workforce is accompanied by higher turnover. In the call-centers, the annual turnover exceeds 50%, and among IT providers, it is about 15-30%, while the turnover has risen up to 40% in the BPO sector (Schaaf, 8).
The high turnover is a result of demand being less than supply, and the huge supply of skilled workers is a direct consequence of the ever-increasing pay rates in these sectors. Average nominal pay increases by 12-15% annually, thus making it an attractive job to acquire (Schaaf, 8). In particular, the smaller firms are having a difficult time maintaining their experienced staff. They are being attracted by the established big players who offer them better package – higher salary, better stock options and employee friendly conditions (Schaaf, 8).
This high turnover is making the IT unemployment rate higher. Many IT-graduates who don’t have enough skills to be selected by the companies remain unemployed.
One of the main hindrances for the Indian IT – companies and their western clients is the weak physical infrastructure. One or two hours of power outages are common in India, and sometimes these power shortages last even for days. Such hindrances waste lot of money and time. In order to prevent such frequent disturbances, many companies incurred an additional expense in setting up their power supply.
Transportation network is also pathetic in India. Roads are not properly paved and traffic in big cities is miserable, especially during rush-hour. Railway system is obsolete, and it makes transportation of goods and passengers complicated. Ports and airports are also not different. There are more non-operating airports than operating ones (Sagar, 7).
Counteractive actions, however, are on political agendas. In September 2003, the Government announced plans to carry out the modernization of Delhi and Mumbai airports. It is envisaged that two separate public-private joint venture companies will be formed to manage the airports and each of these companies will be granted a lease of the particular airport it is to manage (Sagar, 8).
On top of these obstacles, political and security risks still remain. Despite the recent harmony, the Kashmir issue is still no reconciled. Frequent security checks make traveling in India difficult and bothersome (McDonald, 21).
Despite few shortcomings, India still is the leader in global IT development and outsourcing. India’s control in this cutting-edge sector is based on its comparative advantages, not just because of the wage differential. India has comparative advantage in terms of its English speaking high-skilled workers, earlier head start in software development, and a bunch of other factors.
The success in development of IT-sector led to India’s service sector getting a bigger share of the economy’s value added sphere, and the experiences and expertise gained by the managers and workers led to the sector achieve economies of scale. Outsourcing also gave lot of employment opportunities for the Indians; currently, Bangalore employs more engineers than Silicon Valley. Education competitiveness was also brought to a whole new level with the start of western multinationals establishing their operations in India
However, the Indian IT sector is not just filled with roses. There are negative consequences, and the wage differential is the main problem that is pointed out by the critics. Only 30% of the population is located in the urban areas, and the rest is still in rural India with no access to electricity and basic necessities. Moreover, this development is not uniformly stretched in all the urban areas; it is concentrated in just a handful of cities. This uneven allocation is viewed by many critics as one of the major problems with the development of IT-sector.
Even though there are no threats for India in the foreseeable future, there are still challenges India has to overcome in order to retain its current position. The country’s weak physical infrastructure is one of the problems that are frequently faced by the companies, frequent outages in power supply, and poor transportatison network makes it difficult to perform work at its best quality.
India’s position is increasingly being challenged by emerging nations like Russia, China, and few Eastern and Middle European nations. Russia and the Middle-East European nations are currently trying their best to deprive India of its Western clients. Another threat is posed by the big multinationals like IBM who are expanding their outsourcing establishments in cheap-labored economies.
The government and the companies started taking counter action against these problems. The Indian companies are climbing up the value chain and they are trying to expand their horizon, by recruiting people from different nations, and establishing subsidiary offices in USA and Europe to create a firsthand contract with its clients.
Broader base reforms should be introduced in order to make the best use of its comparative advantages. Reforms should give special emphasis on improving education, both in length and depth, making them superior to their competition. Reducing regional differences should also be a priority, in order to reach the growth to a broader mass. India, however, should not focus merely on service sector, like its Asian counterparts, India should still try to establish a strong manufacturing industry in order to create opportunity for the larger mass of its population who are still dwelling in rural India, living a subsistent life.
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