Technology Enabled Services

8/9/2019 Technology Enabled Services

1/39

Information-Technology-Enabled Services and India's Growth Prospects [with Comment andDiscussion]Author(s): T. N. Srinivasan and Anne KruegerSource: Brookings Trade Forum, , Offshoring White-Collar Work (2005), pp. 203-240Published by: The Brookings InstitutionStable URL: http://www.jstor.org/stable/25058767Accessed: 10/08/2010 01:40

Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at

http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless

you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and youmay use content in the JSTOR archive only for your personal, non-commercial use.

Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at

http://www.jstor.org/action/showPublisher?publisherCode=brookings.

Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed

page of such transmission.

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of

content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms

of scholarship. For more information about JSTOR, please contact [email protected].

The Brookings Institution is collaborating with JSTOR to digitize, preserve and extend access toBrookings

Trade Forum.

http://www.jstor.org
http://www.jstor.org/stable/25058767?origin=JSTOR-pdfhttp://www.jstor.org/page/info/about/policies/terms.jsphttp://www.jstor.org/action/showPublisher?publisherCode=brookingshttp://www.jstor.org/action/showPublisher?publisherCode=brookingshttp://www.jstor.org/page/info/about/policies/terms.jsphttp://www.jstor.org/stable/25058767?origin=JSTOR-pdf


2/39

T. N. SRINIVASANYale University

Information- Technology-EnabledServices and India's Growth Prospects

Duringthe first three decades (1950-80) of India's planned insular economic

development, real GDP grew at an annual average rate of around 3.75 percent. The 1980s saw a limited opening of the economy and hesitant reforms. Thegrowth rate accelerated to 5.7 percent, fueled by fiscal profligacy financed in partby external borrowing at high interest rates. A severe macroeconomic andbalance-of-payments crisis in 1991 following the first Gulf War, the collapse ofthe Soviet Union (which was not only India's model for planned economicdevelopment but also its arms supplier, a partner for barter trade, and a supporterof India's interests in the Security Council of the United Nations), and the fearof being left behind by the rapid growth of China since its opening in 1978 ledIndian policymakers to break away from its inward-oriented, state-directed, andcontrolled development strategy and open the economy to external competitionand investment.

After addressing the crisis with the assistance of the International MonetaryFund and theWorld Bank, the policymakers launched a process of systemic economic reforms that is still in progress. The economy responded to the reforms andquickly rebounded from the crisis-induced fall in growth of GDP to 1.3 percentin 1991-92. The growth rate accelerated, peaking at 7.8 percent in 1996-97. Subsequently it has fluctuated, falling to a low of 4.0 percent in 2002-03, largelybecause of a severe drought-induced decline in agricultural output, and rising toa peak of 8.5 percent the very next year, in large part owing to the recovery ofagricultural output (MOF 2005, appendix table 1.6). The latest available datashow that in the fiscal year of 2004-05, GDP growth was estimated at 6.9 percent,

I thank Lael Brainard, Susan Collins, Kanwal Rekhi, AnnaLee Saxenian, and Nirvikar Singhfor their comments.

203


3/39

204 Brookings Trade Forum: 2005and in fiscal year 2005-06 it is also expected to be around that level (RBI 2005a,table 1).

India's record of sustainedgrowth

since 1980 is second only to China'samong large economies, somuch so that, in discussions about global economicprospects generally or about global demand for natural resources (including,

most important, fossil fuels), the impact of Chinese and Indian growth is explicitlymentioned. However, India has succeeded only modestly in raising its shareof world merchandise trade to 0.8 percent in 2004 from a low of 0.5 percent in1983, while China's share has more than quintupled, from 1.2 percent to 6.4 percent, during the same period. China ranked third from the top in the share ofworld merchandise trade in 2004, while India ranked a distant thirty-first in 2003(WTO 2005, appendix tables 1 and 3;WTO 2004, table 1.3). In global trade incommercial services (inwhich trade in information-technology-enabled services[ITES] and business process outsourcing [BPO] are included),1 India has donerelatively better, with a share of 1.5 percent and a rank of twenty-one in 2004 ascompared to China's 2.8 percent share and ninth rank (WTO 2005, appendixtables 2 and 4). Both China and India are expected to gain a significant share ofthe global market of textiles and apparel with the expiration of the infamous

Multifibre Arrangement. Apparel imports from China are already being targetedfor restrictions by theUnited States and the European Union, and China itself isrestraining exports in anticipation. Similar actions against Indian exports arepossible, although India as a founding member of theWorld Trade Organization(WTO) is not subject to the special provisions of China's Agreement of Accession to theWTO that have been used to restrict China's exports.

India's software services exports in 2003-04 amounted to $12.2 billion, ornearly half the total services exports of $24.9 billion. Earnings from ITES andBPO accounted for another $3.6 billion (RBI 2005b, p. S343; MOF 2005,p. 111).2 A high-level strategy group set up by the All IndiaManagement Association (AIMA), comprising leaders from industry, academia, and the govern

ment, deliberated on the opportunities for providers in India in the growingglobal market for remote services (IT services such as software, ITES, telemed

1. As will be clear from my subsequent discussion, a range of services is included under theumbrella of ITES. BPO is a significant enough category of ITES to be broken out separately; ITservices themselves, which are treated in a different category, are also inherently "IT enabled."

2. Data from Indian sources on India's exports of computer and information systems to theUnited States and data on imports of the same services by the United States differ. On the reasonsfor this difference and adjustments to narrow it, see WTO (2005, box 2, p. 280). There is a presumption that Indian data on exports include the earnings of its nationals working in the UnitedStates on a temporary basis. They are also apparently included in the total employment of the sector in the Indian data.


4/39

T. N. Srinivasan 205icine, and learning) and services sought by visitors to India such as conventionaltourism, health care, and education.3 The group consulted wide segments ofsociety and decisionmakers, and its findings

wereprocessed by

a task forcecomprising AIMA, the Confederation of Indian Industry, and the Boston Consulting Group to formulate an action program. The task force concluded thatlack of coordination among various stakeholders toward achieving a commongoal was why India had been relatively slow in availing itself of the emergingopportunities (AIMA 2003). It views its report as a first step in a process ofbringing about coordination and aligned actions. For the purposes of this paper,it is enough to note the growth and employment implications of the opportunities that the task force identifies. It finds that, by 2020, India can hope to generate $139 $365 billion of additional revenue from the supply of remote servicesfor foreign residents and in situ services for visitors, pushing up the GDP growthrate by an additional 0.6-1.5 percent per year between 2002 and 2020. It esti

mates the direct and indirect employment generated by this additional growth tobe between 20 million and 72 million.4 To put these numbers in perspective,India is targeting GDP growth of at least 8 percent per year in the next twodecades. Its labor force, estimated at 363 million persons in 1999-2000 (MOF2004, table 10.7), is expected to grow by 1.5 percent per year in the next twodecades. If that happens, 125 million persons would be added to the labor forceduring the period. IT job growth projected by AIMA could provide jobs for asignificant share of these additions to the labor force, assuming that each IT

worker is fully employed.The methodology of projection by the task force is not explained by AIMA.The possibility that the projections of revenues and employment are very optimistic cannot be ruled out. However, for the very near term, official projections

are also available (MOF 2005, box 6.2). The Ministry of Finance expects valueadded by the IT sector (including ITES) to grow to 7 percent of GDP by 2008from around 2.64 percent in 2003-04. Exports of this sector are expected to bebetween $57 billion and $65 billion, accounting for 35 percent of total exports

3. The last category does not directly come under the umbrella of ITES, but just as the development of IT services created positive spillovers for ITES, the latter, by improving informationflows and infrastructure, support the development of tourism and health and education services fornonresidents. Thus this third category is also discussed in this paper.

4. AIMA (2003, p. 16).WTO (2005, p. 283 and appendix table 8, p. 301) cites India's NationalAssociation of Software Service Companies (NASSCOM) as its source for data on employmentin India's software industry. It reports employment of 813,000 in 2003-04 and employment

growth of 21 percent in that year alone. If this rate of growth is sustained over sixteen years,employment would grow to 17.2 million, generating additional employment of 16.4 million in thesoftware industry alone between 2003-04 and 2019-20.


5/39

206 Brookings Trade Forum: 2005in 2009, a rise of 14 percent from 2003-04. ITES/BPO exports rose from$0.57 billion in 1999-2000 to $3.6 billion in 2003-04 and are expected to riseto $21-24 billion by 2008. The fact that India's share of world IT spending wasonly 3.4 percent in 2003-04 suggests that there is still considerable potential forsignificant further growth.Services imports from and BPO to India have attracted and continue to attract

media attention in the United States. They have also evoked a protectionistresponse: "State legislators have introduced at least 112 bills in 40 states torestrict outsourcing till March 17 this year [2005].... The New Jersey bill,

which awaits the governor's decision to sign or veto, would be the most farreaching anti-outsourcing measure in the country by prohibiting all state contractwork from being performed overseas."5 All this is indicative of the fact that notonly within India, but also in the rest of the world, India is expected to be a

major player in the IT industry in general and in BPO in particular. The emerging consensus is that India will continue to grow rapidly in the next severaldecades, and that its IT sector, broadly speaking, will contribute significantly notonly toGDP growth but also to employment generation and poverty alleviation.

In what follows, I trace the development of India's IT sector and the continuing role of the Indian IT diaspora in the Silicon Valley in the United States. Ithen briefly discuss the possible role of IT in the growth process and as a sourceof dynamic comparative advantage and look in some detail at the prospects ofand possible constraints on India delivering the high expectations about its ITsector.

The Development of India's IT Sector

Prima facie, it is a surprise that India has been able to achieve as much as ithas in IT development.6 India is still a low-income country with gross nationalincome per capita of $540 (ranked 159th from the top) using World Bank's Atlas

method of calculating exchange rates, or $2,880 at purchasing power parityexchange rates in 2003 (146th from the top). Even the IT indicators for India arenot impressive: with 7.2 personal computers per 1,000 people in 2002, India is

5. Suman Guha Mozumdar, "BPO Scare Intact: 112 Anti-Outsourcing Bills Moved," IndiaAbroad, May 6, 2005, p. A26. The United States is among thirty or more members of the WTOwho are signatories to the plurilateral code on government procurement. The New Jersey measure could be in violation of the code. However, since India is not a signatory to the code, it cannot avail itself of the provisions of the code to dispute the measure.

6. This section draws on Kapur (2002) and Saxenian (2002a).


6/39

T. N. Srinivasan 207at just about the average of 6.9 for low-income countries and one-quarter ofChina's 27.6. Indian has 17 Internet users per 1,000 people, just about the average of 16 for low-income countries, but still only one-quarter of China's 64.India spent 3.7 percent of its GDP on IT in comparison with China's 5.3 percent(World Bank 2005, tables 1.1 and 5.II).7 Given this apparent backwardness,

Kapur rightly asks why India emerged as a leader "in a leading edge industrywhen, despite strenuous (and, in retrospect, misguided) policies, it failed toachieve such leadership in any other technology-intensive sector" (2002, p. 93)(with the possible exception of pharmaceuticals). He is again right in rejectingas inadequate and incomplete the explanation that the onerous economic controlregime that was in place, certainly during 1950-80 and arguably until thereforms of 1991, had not intervened in the software sector, and given India'sendowment of science and technology manpower, comparative advantage considerations would have enabled the development of the IT sector anyway. At adeeper level, why indeed the state's role eventually became more facilitativethan constraining in this sector remains to be answered.

Saxenian (2002a) points out that it is not entirely appropriate to conclude thatthe self-sufficiency-oriented, insular development strategy of India since 1950did not affect the development of the IT sector adversely; indeed it did, byrestricting imports of computer hardware (even if the importer committed toexporting a certain amount of software) through high tariffs and limits on foreignexchange allocations, and above all by insulating Indian industry from its globalcounterparts. She notes that IBM was forced to depart from India in 1978, pri

marily because of its refusal to comply with the requirements of India's draconian Foreign Exchange and Regulation Act.Kapur (2002) suggests that the departure of IBM and heavy protection of

domestic hardware raised the relative costs of hardware and technology acquisition.8 The rising costs induced the industry to develop software skills in

7. According to UNDP's (2005) technology achievement index (a composite of disparateindexes ranging from patents granted to residents to gross tertiary education enrollment ratio),India ranked sixty-third, behind Trinidad and Tobago with a rank of forty-one and China with arank of forty-five! India, though included among the group of dynamic adopters, barely managedto escape being included in the groups of marginalized countries (Nicaragua, ranked sixty-fourth,leads the group of marginalized). This says more about the dubious value of this index and others(such as the Human Development Index) put together by the UNDP than about the technologicalachievement of the countries ranked and groups.

8. It is interesting that the Chinese prime minister started his April 2005 visit to India at Bangalore, India's IT capital, and there were euphoric statements at official and unofficial levels of thepossibility of joint efforts to capture a large share of the global market by capitalizing on China'scapabilities in hardware and India's strength in software.


7/39

208 Brookings Trade Forum: 2005response. While this is plausible, until the disincentives of the autarkic systemwere attenuated (and indeed reversed and turned into incentives), the skills sodeveloped would not have led to the spectacular growth of software exports inparticular, and of the IT sector in general. Both Kapur and Saxenian note thatthere was a dramatic turning point in the policy environment for India's software and IT industries after Rajiv Gandhi became prime minister in 1984. The

major policy changes made by his regime included recognition in the Computer Policy announcement of November 1984 of software as an "industry"entitled to the investment and other incentives available for domestic industries; lowering of import tariffs (from 100 percent to 60 percent) on softwareand personal computers; and the announcement in 1986 of the Computer Software, Development and Training Policy, which liberalized access to the latesttechnologies and software tools for promoting the domestic software industry,

with the expectation of its becoming globally competitive, moving up thevalue-added ladder, and capturing a significant share of global softwareexports. The policy allowed import of software in any form, invited foreigninvestment, and promised access to venture capital. There cannot be a moredramatic departure than this policy from the strategy of technological selfreliance, import substitution across the board (from intermediates to capitalgoods), and export pessimism. Another important event of the 1980s was thevisit toNew Delhi in September 1989 by JackWelch, then chairman of General Electric (GE), and his breakfast meeting with Sam Pitroda, the chief technology adviser to Prime Minister Rajiv Gandhi. It led toGE's technology partnership with India, which began in 1991.9

The 1984 and 1986 policy initiatives were enabling in the sense of removingpolicy-created barriers to the growth of the software sector, but the policies didnot become proactive until after the reforms of 1991. Saxenian quotes an indus

9. "India today earns more than $17 billion from corporations world-wide seeking low-costoverseas talent to do everything from write software to collect debts to design semiconductors. GEin large measure stoked the phenomenon, playing an unheralded role as the Johnny Appleseed onIndia Inc. and reaping billions in savings for itself along the way.

But the strategy has been pivotal for GE. In 2000, it inaugurated a Jack F. Welch TechnologyCentre in Bangalore that employs thousands of researchers working on everything from newrefrigerators to jet engines. This year, the conglomerate plans to spend about $600 million oncomputer-software development from Indian companies, according to a recent company report.The company estimates that similar products would cost it as much as $1.2 billion in the US. GEalso recently unleashed a big new player in Indian outsourcing. InNovember, it sold a controllinginterest in GE Capital International Services, or Gecis, a company with about 17,000 employeesthat GE started in 1997 to answer mail from its credit-card customers." Jay Solomon and Kathryn

Kranhold, "Early Investments Helped Fuel Tech and Service Sectors," Wall Street Journal, March23, 2005.


8/39

T. N. Srinivasan 209try analyst: "Until 1991-92 there was virtually no policy support at all for thesoftware sector. Even the term 'benign neglect' would be too positive a phraseto use in this connection" (2002a, p. 172). She notes the lack in the 1980s ofinternational communication links for software exports and cites the example ofTexas Instruments which, in setting up the first earth station in Bangalore in1986, had to negotiate with the authorities for the removal or breaking of twentyfive different government rules relating to export of data via satellite links. Theabsence of reliable telecommunications links forced Indian firms to be primarily"body shoppers," who provided programming services on-site, typically in theUnited States, to customers under contract.

All of thischanged

in the 1990s. Telecommunications reforms, which beganin the mid-1980s and included privatization and the creation of a regulatoryagency, were very successful, although the process was not smooth because ofthe resistance of state-owned monopolies. Telephone calls within and from Indiaare perhaps the least expensive in the world. The Department of Electronicsintroduced the scheme of Software Technology Parks (STPs) in the early 1990s.An STP is the analogue of an export-processing zone. Firms in STPs wereallowed tax exemptions, guaranteed access to high-speed satellite links, and provided with reliable electric power and basic infrastructure, including core computer facilities, ready-to-use office space, and communications facilities. Theywere allowed to import equipment duty-free and without import licenses. Full(100 percent) foreign ownership was permitted in exchange for an export obligation. Firms were also allowed to repatriate capital investment, royalties, anddividends freely once they paid the taxes due.10 The STPs played amajor role inthe development of the IT sector in the 1990s. The share of units located in STPsin India's software exports rose dramatically, from 8 percent in 1992-93 to81 percent ten years later (WTO 2005, box 1, p. 274). However, there is no hardheaded social cost-benefit analysis of the use of public resources in the creationof STPs and the provision of other incentives.There were also several somewhat fortuitous factors. First, as Kapur notes,the restrictions on large business houses entering new fields under theMonopolies and Restrictive Trade Practices Act (which was repealed de facto only after1991) prevented most of them from exploiting the newly emerging opportunitiesin the IT sector. Only one of the very successful IT enterprises (namely, Tata

10. China provided all of these incentives and more (in particular, complete flexibility in hiring and firing) in its special economic zones (SEZs) to attract investment, particularly foreigndirect investment that was oriented toward export markets. But India's STPs focused only on software. India's later embrace of SEZs did not attract much FDI or lead to rapid growth of exports,in contrast to what happened in China.


9/39

210 Brookings Trade Forum: 2005Consulting Services) belonged to a large industrial house. Although large houseshad substantial capital and other resources at their command, and precluding orrestricting them could have been crippling, this did

nothappen

in theemergingsoftware and IT service industry since itwas not very capital-intensive. Besides,

small and medium-sized enterprises are usually themost innovative elsewhere inthe world, and the Indian IT enterprises were no exception. Second, India hadinvested disproportionately in higher education in general and, in particular, hadestablished the elite Indian Institutes of Technology (IITs). Although IIT graduates emigrated in significant proportions to the United States and accounted forless than 5 percent of the engineering graduates in India, the impact of migr son the development of India's IT sector, particularly in the 1990s, was significant(more on this in a later section).

As in the United States, India's IT sector is also concentrated, located inclusters in Bangalore, Chennai, Hyderabad, Mumbai, New Delhi, and Pune.These cities also had the highest concentration of public sector R&D establishments (especially defense) as well as publicly funded engineering colleges.Five of these (other than New Delhi) are in theWest and in South India. Thestates in which the five are located, namely Maharashtra (Mumbai and Pune),

Karnataka (Bangalore), Tamil Nadu (Chennai), and Andhra Pradesh (Hyderabad), together accounted for 64 percent of the annual intake of engineeringcolleges in 2003, even though their share of India's population is only 27 percent (Forbes 2003, table 3). Indeed, these were the states that had the largestexpansion of engineering colleges since 1983 when, in amajor liberalization,privately funded institutions without state aid were encouraged. In Forbes'sview: "It is this expansion of engineering education that fueled India's softwareboom, and it is no accident that the states with massive private expansion ofengineering education are precisely those where the software industry islocated" (Forbes 2003, p. 8).

The Y2K crisis brought prominent global attention to the skills of Indian software engineers. Indians had become good at converting old mainframe andminicomputer applications toUnix applications in the 1980s and early 1990s. Itwas essentially a tedious task that Americans were not willing to undertake.However, it directly prepared Indians forY2K by giving them expertise in applications and also the reputation for reliable work. Y2K work accelerated theprocess, but the previous application conversion work was the base on which thewhole thing was built.11 According toDataQuest,

11.1 thank Kanwal Rekhi for pointing this out in a private communication.


10/39

T. N. Srinivasan 211Y2K... triggered off a chain of events. Exports grew on the strength ofY2K and never looked back. The local training industry boomed partiallybecause of it.... Locally, full-page government ads in leading dailies, asking companies to become "Y2K-compliant," helped the paranoia along.

By the end of 1999, the industry was on an all-time high. IPOs of softwarecompanies were getting oversubscribed several times.... This gave rise toaminor scandal that rose and fell fly-by-night operators who often hadno business at all started putting IT in their names and entering the IPOmarket. They made money; a lot of investors lost theirs.12

Whether or not itwas fortuitous, the 1986 report of the Rangarajan Committeeon Modernization of India's largely state-owned banking sector recommended"standardizing banking systems on Unix, then an unperfected operating systemwhen compared with MS-DOS. The government floated a tender for 400 Unixsystems and set off a scramble among Indian companies to come up with aUnixplatform. Though the local part of the contract eventually went to Sunray Computers, the report led local vendors into the Unix arena and eventually India'stransformation into a 'Unix country.'"13 It is possible that Unix would have beenattractive to a developing country such as India even had the committee not recommended it: itwas a semi-open source developed for larger, more powerfulcomputers than PCs, for which the totally proprietary MS-DOS was developed.Other competitors for Unix were also totally proprietary. Later, in the 1990s,Unix turned out to be ideal for networked computing, and Unix-based systemsstill dominate the Internet server realm.14

The sources of the spectacular development of India's IT sector are diverse.There is no doubt that the foundation of a skill base existed for its development inthe 1980s, in large part due to public investment in higher education and the creation of elite engineering schools. The public policy regime mattered, both negatively in restricting the potential development of the sector until themid-1980s,and positively when it changed gradually from enabling its development before thereforms of 1991 to proactively supporting its growth thereafter. Fortuitous orserendipitous factors, depending on one's point of view, contributed as well. Fromits beginning in body-shopping and routine programming, the industry has grown

12. DataQuest, "The Hot Verticals: The Great Indian Software Revolution," December 23,2002, p. 5 (www.dqindia.com/content/20years/102122306.asp [September 13, 2005]).13. DataQuest, "The Hot Verticals," p. 3.

14.1 thank Nirvikar Singh for pointing this out.


11/39

212 Brookings Trade Forum: 2005Table 1. The Indian IT Industry, 2003-04

Domestic

2003-04 Growth,2003-04

(percent) Exports

Units Value7" Units ValueValue, Growth

2003-04* (percent)HardwareSystems: ServersTotal non-PC serversTotal PC servers

Total serversSystems: WorkstationsPersonal workstationsTraditional workstations

Total workstationsSystems: Single-user systemsDesktopsNotebooks

Total PCs

4,393 1,17052,609 91257,002 2,08212,0783,10015,178

Total systemsPeripheralsTotal printers/MFDOther peripheralsTotal peripheralsNetworkingTotal hardwareTotal hardware services

1,382,993

99122221

2,691,823 8,01490,680 7362,782,503 8,7502,854,683 11,053

1,3333,1634,4962,978

18,5273,142

145046

732961

21882223

21

133421

134428

801214

335447322339

-100

2,200 72

2,300 5910 -67

(continued)

in depth and scope. I conclude this section with a description of the industry as of2003-04.

The hardware component of the industry is still small, accounting for a littleover one-fifth of the total value of output (see table 1). Exports accounted fornearly two-thirds of total output, of which software and BPO services had sharesof 67 percent and 28 percent, respectively. It employs fewer than amillion workers out of a labor force of 363 million. According to India Today, "Still, thebuoyant BPO sector is absorbing English-speaking graduates in the thousands.In 2005, IT & ITES will be the biggest job generator, creating more than2.75 lakh [275,000] jobs. India's huge cost advantages with quality assurancesand large pool of skilled manpower will keep the going smooth. More than 250of the Fortune 500 firms outsource their IT needs to India. There ismore growth


12/39

T. N. Srinivasan 213Table 1. The Indian IT Industry, 2003-04 (Continued)

Software ServicesCustomized software

Turnkey projectsConsulting/othersTotal software servicesBusiness process

outsourcing (BPO)Training ServicesTotal training servicesTotal servicesGrand total

Domestic

2003-04Growth, 2003-04

(percent) ExportsValue, GrowthUnits Value* Units Value 2003-04* (percent)

1,710

3,3001,951

6,961

1,450

99212,54533,374

-10

306924

53

-122624

27,7551,586

10,30939,65016,380

11056,150

18

111545

292259,550 24.5

Source:DataQuest, "IntellectualProperty:India:Sleeping IPGiant" (www.dqindia.com/dqtop0/2004 [December2005]).a.RupeesCrore (107 rupees);US$1 = 48 Rs.

in store" {India Today, March 2,2005, p. 14). The same story reports that the topfive IT and ITES firms pay an annual salary of $4,500-$6,250 for an engineering graduate, roughly ten to twelve times the per capita income of the country,one-sixth of the annual average U.S. salary in 2000, but less than that of anemployee of the occupations at risk of being off shored in the United States (seealso Bardhan and Kroll 2003, table 4).

The Indian industry is no longer confined to producing and exporting low-endsoftware products and services. Several multinational companies (MNCs),including many leading ones, have established software development centers inIndia. DataQuest reports that such MNC centers are filing for patents in largenumbers (1,108 in 2002-03).15 It suggests that intellectual property revenueswould constitute amajor chunk of a software company's revenue in the future,and Indian companies (other thanMNCs), including some of the large ones,have not yet started preparing for it.Leading Indian IT firms, such as Infosys and

Wipro, aremultinational with offices around the world and employ nationals inthese countries. Infosys has alliances with the world's leading firms, including

15. DataQuest, "Intellectual Property: India: Sleeping IP Giant" (www.dqindia.com/dqtop20/2004 [December7, 2005]).


13/39

214 Brookings Trade Forum: 2005IBM, Intel, Microsoft, and Oracle, and also has made strategic acquisitions offoreign firms. The story is similar forWipro; it is aggressively looking at companies to acquire in the enterprise, finance, and consulting areas.

NASSCOM (2004, p. 9) documents the increasing maturity of the industryfollowing a large number of mergers and acquisitions in 2002. It noted that traditional IT service players have added ITES-BPO portfolios to their existingofferings in order to provide a complete umbrella of end-to-end services. Multivendor and build-operate-transfer (BOT) contracts that offer customers advantages such as low risk, scalability, and competitive pricing have increased. Indianvendors are expanding the spectrum of their service offerings in client locationsand even setting up facilities in other low-cost ITES-BPO destinations such asChina and the Philippines in order to tap those markets. They are also moving upthe value-added ladder to offer high-end services such as equity research andanalytics, as well as insurance and technology support and development.

Moreover, Indian vendors have moved far beyond call centers into financialservices, telecom, retailing, and automotive segments of the ITES-BPO sector.In financial services, Indian companies are offering customers services centeredon accounting, billing and payment services, and transaction processing. Overthe past few years, some Indian service providers have also been offering highervalue services to customers in the areas of insurance claims processing andequity research support. They expect to gain from offshore outsourcing of customer and technical support and product development by the global telecomindustry; transaction processing, billing, telemarketing, and inventory management for large retailers; and engineering activities, such as computer-aided product and tool design, claims processing, and accounting processes for the auto

mobile industry (NASSCOM 2004, p. 10). The report also benchmarked theperformance of Indian industry on key operational issues with global benchmarks. It found that Indian industry is able to deliver at levels comparable totheir international counterparts on parameters such as quality, customer satisfaction, and between quality and customer satisfaction.

Finally, letme turn to some relatively recent developments in the provision ofservices to tourists and visitors to India. As the home of an ancient civilizationand of several ethnic and religious groups (Hindus, Buddhists, Jains, Sikhs,

Muslims, Christians, Jews, and Zoroastrians) over millennia, India has manyancient monuments, including churches, mosques, synagogues, and templesbesides the Taj Mahal. Of course, the diversity of its flora and fauna, the peaksof the Himalayas, and other natural beauty also attract tourists. However,because of the inadequacy of affordable quality hotel rooms, transport, andcommunications, India failed to attract as many tourists as even much smaller


14/39

T. N. Srinivasan 215countries of the region. This is changing: tourist arrivals grew by 24 percent in2004, and India is fast emerging as one of the top ten tourist destinations in the

world, according to theReserve Bank of India (RBI 2005a, p. 80). However, unconventional tourism is also on the rise. In particular, medical tourism is growing. According to several recent newspaper reports, the availability of worldclass treatment at a fraction of the cost in the United States or Europe isattracting up to 100,000 to 150,000 foreign patients to quality hospitals acrossIndia, representing a tenfold increase over just five years ago. Many of these hospitals were established and are staffed by Indian doctors who had emigrated toand practiced for a long time in the United States and Europe. Another unconventional service is education institutions of higher education are attractingstudents from other South Asian countries. Recently, two premier institutions,the Indian Institute of Management at Bangalore and IIT inMumbai, havestarted programs in Singapore in collaboration with the National University ofSingapore. Also, drug trials and sponsored research in the pharmaceutical industry are being outsourced to India.16

The Indian Diaspora and ITES SectorThe IT revolution, particularly the development of the Internet, has spawned

networks of engineers and scientists who are transferring technology, skill, andknow-how between distant locations, and more flexibly than most corporations.17 Among foreigners in the United States, Indians were second only toSouth Koreans as recipients of U.S. Ph.D.'s in engineering and science in 2003.Indian engineers were at the helm of a significant and growing number of Silicon Valley-based technology companies. The proportion of companies run byIndians has grown from 3 percent of those started between 1980 and 1984 to10 percent of those started between 1995 and 2000, and is probably even higher

16. India's success in producing generic equivalents of patented drugs is owed in part to India'sdecision since 1970 to grant only process and not product patents in the pharmaceutical industry.This success became internationally visible when Indian companies became able to supply genericantiretroviral drugs to treat AIDS far more cheaply than the multinational companies. With Indiabecoming a signatory of the TRIPS (Trade Related Aspects of Intellectual Property Rights) agree

ment, Indian patent law had to be amended inMarch 2005 to grant product patents as well. Thereis a real danger that the generic industry will be destroyed by this amendment (see Abbott,Kapczynski, and Srinivasan 2005). On the other hand, because the Indian pharmaceutical industry has built a reputation for quality, drug trials and sponsored research are being outsourced toIndia.

17. This section draws on Saxenian (2002b).


15/39

216 Brookings Trade Forum: 2005among those started after 2000. Further, data from the U.S. Bureau of the Census show that the Indian share of Silicon Valley's science and engineering grewfrom 2 percent (400 workers) in 1970 to a significant 13 percent (20,000 workers) in 2000, most of the increase having taken place in the 1990s.18Members ofthe two professional associations of Silicon Valley, The Indus Entrepreneur(TIE) and Silicon Valley Indian Professionals, and those who held senior positions inU.S. companies, were instrumental in convincing their senior management to establish operations in India. As India built a reputation as a supplier ofsoftware, most Silicon Valley technology companies established their owndevelopment centers in India. The dot.com bust resulted in some SiliconValley-based Indians returning to India and setting up enterprises of their own.Saxenian (2002b) rightly stresses the growing influence of the Silicon ValleyIndian community in Indian policymaking. One of the doyens of the community,often called the "sage of Silicon Valley," Kanwal Rekhi, former chief technologyofficer atNovell, has been a vocal advocate of policy change in India. In his regular visits to India, he has met with senior policymakers at the central and statelevels. He deserves much of the credit for the breathtaking scope of India'stelecommunications reform and its success. But for his very public attack on theentrenched bureaucracy of the Department of Telecommunications (DOT), it isunlikely that the reform would have proceeded very far.19K. B. Chandrasekhar, another Silicon Valley entrepreneur, led a committee in1999 on venture capital (VC) for the Securities and Exchange Board of India.The committee's report provided a comprehensive vision of the growth ofIndia's VC industry. The industry has had remarkable growth since the report. In2004 nonresident Indian (NRI) entrepreneurs led by the Silicon Valley giantsprepared an action plan for attracting substantial foreign direct investment (FDI)to India and presented it to the government in January 2005. It has been wellreceived and some of its recommendations have already been implemented.There is no doubt that their success in the global market is themain, if not theonly, reason for their not only being heard with respect but actively sought afterby policymakers.Three prominent Silicon Valley entrepreneurs, Vinod Khosla (of Sun Microsystems fame), Kumar Malavalli (of Brocade Communications Systems), and

Kanwal Rekhi, realized that to change policy successfully, three ingredients areessential: sound, policy-oriented research from academics to provide the foun

18.1 thank AnnaLee Saxenian for drawing my attention to these data.19. He coined the Hindi slogan "DOT Hatao-Desh Bachao," which means "Curb the DOT and

Save the Nation!"


16/39

T. N. Srinivasan 217dation for policy advice; discussion and debate of the proposed policy advice ina forum consisting of academic researchers, prominent politicians, bureaucrats,and media representatives; and monitoring of the implementation of the advice.The three took the initiative to provide significant resources to Stanford University's Center for International Development for sponsoring and undertaking policy research on India's economic reform and organizing a conference at whichresearch findings and policy recommendations following from them are presented. Five annual conferences have been held since 2000; two conference volumes have been published, and a third is in press. The sixth conference was heldin June 2005. Besides supporting research at U.S. universities, the Silicon Valley community has also

been active in upgrading Indian institutions, startingfrom the HTs, of which many of them are alumni, and also creating new institutions, such as a business school inHyderabad whose faculty includes regular visitors from topU.S. business schools. Some Silicon Valley entrepreneurs, hailingfrom different states in India, are realizing that policy reforms are urgentlyneeded at the state level in India. A group of TIE members interested inKeralahave formed aKerala Support Group. Others are likely to follow. Finally, at therequest of India's prime minister a group of entrepreneurs and business personsin the Indian diaspora, including veterans of Silicon Valley, got together in fall2004 and came up with practical suggestions for improving FDI flows to India.

Their proposals were presented to the prime minister and the Planning Commission in January 2005. The subsequent removal of some dysfunctional restrictions on FDI and the legal action creating special economic zones were in partthe result of these proposals.

It is clear that the influence of the Indian IT diaspora is spreading beyond thenarrow confines of the Indian IT industry to influence India's economic development and growth more broadly. The demonstrable success of India's IT andsoftware sector in the global market is having a profound impact on Indianindustry and also, importantly, on the educated youth. From a fear of competition, as evidenced, for example, by the demand for antidumping measures(ADMs) against cheap imports, particularly from China (a demand that the government was too willing to agree to, making India the largest user of ADMsamong members of theWTO in the last couple of years), there is now a growing sense of confidence among Indian industries of being able to compete and adesire to view China as a large and growing market to export to, with the resultthat trade with China has grown rapidly. An important aspect of achieving and

maintaining global competitiveness is attention to product and service quality.Again, the reputation for quality that IT vendors have built has not gone unnoticed. India is now poised to become a major destination for outsourcing of


17/39

218 Brookings Trade Forum: 2005manufactured products, as China is already. This is already happening in autocomponents Indian suppliers, like the Chinese, are competitive both in costand quality (Sutton 2005). Indian automakers have recently begun exportingpassenger cars: from 25,000 cars in 1998-99, exports grew to 121,000 in ninemonths of 2004-05 (MOF 2005, table 7.5). Last, there is a sense of confidenceamong the educated youth about the future and in their ability to compete successfully with the best of their cohort from anywhere in theworld, a confidencethatwas noticeably absent not so long ago. These intangible effects are no lessimportant than their tangible ones on the growth of exports, GDP, and employment. Among the most important intangible effects of India's perceived economic success broadly, and in high-technology sectors including

IT and thepharmaceutical sectors in particular (both achieved without in any way compro

mising its vibrant democratic political system), one must include a vast improvement in India's international standing. There is a recognition that India is amajorAsian power, along with China and Japan. It is no coincidence that, in a shortspan of six weeks inMarch and April of 2005, high-level visitors to Indiaincluded the Chinese prime minister, theU.S. secretary of state, the president of

Pakistan, and the UN secretary general. India is a serious contender for permanentmembership

on the UN Security Council if the proposed expansion of thecouncil comes about, though this seems unlikely in the foreseeable future.

The Analytics of the IT Sector in the Growth ProcessThere are many possible channels through which IT could affect an econ

omy's output (its level and possibly rate of growth in a steady state). Singh(2004) focuses on one, namely the reduction of transaction costs through the

useof information technology.20 In his model, a reduction in transaction costsincreases the number of intermediate goods that are produced and in turn influences growth. A representative household supplies labor inelastically and has alogarithmic instantaneous utility function for a single consumption good produced by identical competitive firms with constant returns to scale technologyusing labor and a symmetric composite of differentiated varieties of intermediate goods best viewed as perishable producer services. The composite is a con

20. Information technology can reduce transaction costs in several ways, for example, byreducing search and matching costs, by speeding up and making more reliable the completion oftransactions, by substituting long-distance communications for physical transportation, and byimproving tracking and logistics of delivery. These benefits can be obtained in transactions forintermediate or final goods and services.


18/39

T. N. Srinivasan 219stant elasticity of substitution (CES) aggregate of available varieties at eachpoint in time, with an elasticity of substitution greater than one. This implies thataggregate production

must be increasing in the number of varieties of intermediates (in a symmetric monopolistically competitive equilibrium in which allthe available varieties cost the same and are used in the same amount).

All varieties are produced with the same technology with a fixed start-up costand a constant variable cost, both in units of labor. Finally, transaction costs are

modeled la Samuelson's iceberg transportation costs: intermediate goods producers receive only an exogenously set fraction of what the producers of the consumer goods pay them; the remaining fraction melts away as a transaction cost.Thus any fall in this exogenous fraction is a reduction in transaction cost.There are no forces in this model that can generate sustained growth, since thelabor force is given, and in contrast to Helpman's (1990) model, there is nolearning effect that continuously reduces the fixed cost of producing a variety ofintermediates as their cumulative output grows. Thus Singh focuses on the properties of a steady state, if it exists. It turns out that the relative value of the elasticity of substitution 6 between labor and the intermediates aggregate in the production of the consumption good and that between different varieties in theintermediate aggregate, a, is what matters. Both are assumed to exceed one. If0 < cr, there is a unique value n for the number of intermediates n, such that ifthe economy starts with n0 < n*, it converges to n over time, and if it starts withn0 > n*, it stays at n0. Thus initial conditions do not matter toomuch, in the sensethat any economy starting from n0 below n converges to it. However, n is adecreasing function of the transaction cost.

If 9 > a, there are three possibilities depending on other parameters, includingthe utility discount rate and transaction costs: (i) n stays at n0, so that any initialn0, is also a steady state; (ii) there are two values n *Lnd n *Hith nLn0>n*L, n converges to nH\ and if n0 > n*H,n staysat n0. Thus any initial n0 in the interval (0, n*L]or [n*H, ) is a possible steady state.

However, for an initial n0 in(n*L,n*H) the steady state is n*H\and (iii) again, thereare two values nL and nH as in (ii), but in this case, even if n0 < n*L, the n can converge to nH so that for any initial n0 in (0, n*H] including the value n*L,the steadystate is n*H.Summarizing, transaction costs have three impacts: first, the standarddeadweight loss; second, with higher transaction costs, few intermediates areproduced, leading to lower output of the consumer good and hence lower welfare;and third, theymay arrest the process of change in the sense of keeping the number of varieties of intermediates at their initial level and/or reduce their long-runlevel. Although themodel is useful in illustrating the possible cost of high transaction costs, as noted earlier, its structure precludes the analysis of growth effects.


19/39

220 Brookings Trade Forum: 2005The model in Singh (2002), though not as fully worked out as the above,addresses the growth impacts of IT (including nondigital methods of storing and

communicating information) through an extension of amodel of recombinantgrowth developed byWeitzman (1998). The Weitzman model captures the simple concept that new ideas are formed through combinations of old ideas. Singhfollows Weitzman in focusing on this concept to the case in which ideas can becombined in pairs. Given the possible combinations of pairings, the number ofideas grows exponentially. By decomposing the total stock of knowledge orideas into the stock of IT knowledge and non-IT knowledge, Singh captures thespecial role of IT knowledge. He specifies that the stock of IT knowledge affectsthe growth in stocks of both types of knowledge in the same manner, so that ITstock gives the growth process an "extra kick" even beyond the exponentialgrowth that theWeitzman model produces.21 Singh conjectures that the modelhas a steady-state growth rate, but its comparative statics with respect to theparameters of the "extra kick" term are yet to be worked out.

Let me conclude this section by listing the mechanisms through which ITcould affect the level and growth of output. First, as in the Singh models, IT services are in effect universal intermediates (like energy) that are essential to anyproduction activity and possibly most, if not all, consumption activities. Thusany technical progress in the IT sector reflects itself first in productivity gains (orcost reductions) in the IT sector. Then, as the changes in the IT technology diffuse, as the rest of the economy makes the appropriate investments in equipmentand processes to take advantage of the new lower-cost IT technology, other sectors of the economy will experience productivity gains. Because the diffusionprocess is likely to be gradual, the total factor productivity (TFP) gains will bespread over time. The debate in theUnited States about the contribution of computers and IT to productivity growth is in large part about this diffusion effect(see Jorgenson 2005; Gordon 2000). In India also, the diffusion that has begunwould yield TFP gains over an extended period of time.The mechanisms through which IT affects the level and growth of output areessentially aspects of the diffusion process. First, as IT diffuses, improvementsin the efficiency of resource use would affect the level of output growth both sec

21. The justification of this special role for IT comes from the importance of being able tostore, process, and communicate information effectively: without writing, without telephones,without the Internet, the success rate of converting potential new ideas into actual additions to thestock of knowledge would be lower. As an illustration, the use of IT makes the IT sector itselfmore efficient and innovative (for example, using software for automated testing during softwaredevelopment) as well as providing this benefit to other sectors (for example, using IT to improvethe workings of call centers, or to reduce mistakes inmedical transcription).


20/39

T. N. Srinivasan 221torally and, even more important, intersectorally, as gainful transactions (marketand nonmarket) thatwere previously unavailable became available. Already, im

provement inmarket price information, and hence higher revenues, are beingrealized in some parts of rural India. Another area that positively affects both thelevel and growth of output is IT-based delivery of education at all levels.22In principle, an extensive and effective use of IT in public administrationcould enhance transparency, as well as reduce avoidable time lags and transaction costs. It is also possible that increased transparency in itself could reduceadministrative corruption and malfeasance. It is too early to judge from severalongoing e-governance pilot projects whether these expected beneficial effectsare being realized (Singh 2002, p. 18). However, it is early enough to recognizethe existence and rapid growth of several private (profit-oriented as well as nonprofit) initiatives in addition to publicly funded schemes in India. Singh mentions several of them. There is reason to hope that the diffusion of ITwill gathersteam and contribute significantly to accelerating growth in the not too distantfuture.

Because IT goods and services are tradable internationally, productivity gainsfrom their diffusion to the entire economy should occur regardless of whethersuch goods and services are locally produced. Obviously, whether a countryproduces an intermediate good domestically or imports it is the aggregate outcome of the decisions of its producers of final products to buy the good fromlocal or foreign suppliers. Indeed, these decisions are related to the organizationof firms in the sense that a vertically integrated firm producing a final productproduces the intermediate products it needs, whereas less integrated firms wouldpurchase some of the intermediates they need from others (in particular fromsuppliers who specialize in the production of intermediates); that is, they wouldoutsource such intermediates. When such outsourcing leads to offshoring, theintermediates would be imported. The offshore producer could also be a subsidiary of the offshoring multinational firm, so the purchase transaction would beinternal to the firm. Thus, in general the problem of whether to outsource or offshore has to be embedded in an analysis in which the organization of firms(whether to be vertically integrated, or whether to become multinational thatis, to engage in FDI) is endogenous.In a series of papers Grossman and Helpman model the determinants of thelocation of subcontracted (that is, outsourced) activity in a general equilibriummodel of outsourcing as trade, integration versus outsourcing in the equilibrium

22. Singh (2002) cites the projects "e-choupal," linking the Indian farmer with national andinternational markets, and TARAhaat as examples.


21/39

222 Brookings Trade Forum: 2005organizational structure of industries, and outsourcing versus FDI (2002a,2002b, and 2003). An essential feature of these models is that outsourcing of anintermediate

requires searchingfor a

partner and making relation-specific investments that are governed by incomplete contracts. Naturally, finding a suitablepartner is easier if themarket for intermediates is thick (and thickness can differbetween domestic and foreign markets). Also, whether the intermediate has to becustomized to the specification of a single user (in which case, once it is produced, the supplier has no other user for it than the one for whom itwas customized) or is usable by many, matters for contracting, since the possibility ofthe supplier, once he has produced the customized intermediate, being "held up"

by the user can arise.IT products, such as some software, have characteristics that often involvecustomization. Moreover, such characteristics are at best observable by the supplier and purchasers, but not verifiable by third parties, thus precluding contractsbetween suppliers and purchasers that stipulate a given price for an agreed quantity to be purchased. For a closed economy Grossman and Helpman (2002b)analyze domestic outsourcing in such a context, based on the tradeoff betweencosts of running a larger and less specialized organization in a vertically integrated firm and the costs arising from the search for a suitable partner to outsource and imperfect contracting, were it to outsource.

Turning to FDI, Grossman and Helpman (2003) set forth three possible equilibria. In one, all firms choose to invest in a subsidiary abroad to produce theirintermediates there. In another, all choose to purchase them from independentsuppliers in the foreign country. In the third, some firms opt to engage in FDI andothers in purchase. Which of the three is relevant depends on the values of threeparameters representing, respectively, the price elasticity of demand for any variety of the differentiated final product (assumed to be greater than one), themarginal cost of producing the substitute in a subsidiary abroad, and the difficulty ofcontracting with an independent foreign supplier. With marginal cost sufficientlylow, elasticity of demand sufficiently low (that is, close to one), and the difficultyof contracting sufficiently great, in equilibrium all firms engage in FDI. By contrast, with marginal costs neither too low nor too high, elasticity of demandabove 1 but by not too much, and amoderate difficulty in contracting, in equilibrium some firms do engage in FDI and others purchase. It is conceivable thatthe search and contracting costs will be lower if both supplier and purchaserhappen to be national firms. If this is the case, the gains from having domesticfirms supplying and other domestic firms purchasing IT products could be largein comparison with domestic purchasers buying and contracting with foreignfirms. For this reason, it is likely that firms in non-IT sectors in India would pur


22/39

T. N. Srinivasan 223chase their IT services and products from existing domestic IT firms rather thanimport them. Also, if contracting difficulties are relatively fewer and marginalcost of production relatively higher in India than in China, the Grossman and

Helpman (2003) model would predict more FDI in China than in India.

Future Prospects of the Indian IT Sector: Conclusions

The spectacular growth of software exports as well as ITES-BPO has beenunderpinned both by the relative abundance of skilled workers and by their relatively low cost. NASSCOM (2004, p. 15) points out that the success of theIndian ITES industry is in large part due to the country's immense pool of

English-speaking skilled workers. NASSCOM (2005) estimates the stock ofgraduates (engineering degree and diploma holders, degree holders in the arts,commerce, and science) at 22 million in 2003, with approximately 2.5 milliongraduates in 2004 from about 275 universities and 14,000 colleges in the country.Of course, those numbers do not adjust for differences in the quality of skillsand are not broken down by the skills required for working in different segmentsof the IT sector. For example, the skills required to be employed in a call centerare surely different from those for developing software. NASSCOM (2005)estimates that 250,000 engineering degree and diploma holders entered the

workforce during 2003-04, with a large segment believed to have joined the ITindustry. The industry is estimated to have employed 841,500 professionals in2003-04, of which 270,000 worked in the export sector and 253,000 in the BPOsector. Still, if one assumes that the share of the stock that is employed in theindustry does not change, the implied annual growth rate of the stock at 11.3 percent (the ratio of graduates to stock) is far below the growth of 35 percent that

NASSCOM (2004, p. 15) projects for the value of India's ITES/IT services output for the period 2003-12. Thus, unless the ITES/IT sector's share of the stockgrows or the stock itself grows more rapidly, there could be excess demand forlabor in the sector, and the wages and salaries of ITES/IT workers would haveto increase towipe out the excess demand:

While demographic studies have suggested that India could be one of thefew countries with a surplus of personnel within the employable age groupby 2020, there is a possibility of a shortage in terms of availability ofskilled personnel for ITES/IT, even in the medium term.

This gap could be to the tune of 235,000 for IT services and 262,000for IT-enabled services and could increase in 2012 in the absence of any


23/39

224 Brookings Trade Forum: 2005Special efforts tomeet themanpower requirements. (Government of India2003, p. 6)

Any increase in emoluments of ITES/IT workers in India with no change intheir productivity would cut into the cost competitiveness of India. It is not easyto obtain reliable and well-documented unit costs of IT sources and products forIndian suppliers relative to their competitors in other countries. The followingdata from reports of Evalueserve, a full-service business intelligence, marketresearch, and intellectual property services firm, are suggestive: the costsreported do not include profit margins, which run around 10-15 percent in India,but do include marketing and sales costs:

For IT services, costs range from $11 per hour to $19 per hour for workbeing done in India. $11 per hour essentially corresponds to the lower endIT work that is being done by a college graduate (with a bachelor's incomputer architecture) or a graduate engineer. On the other hand, $19 perhour is for higher-end work being done by people with four or five yearsof experience.For ITES the costs range from $9 per hour to $22 per hour (for workbeing done in India); $9 per hour is essentially credit card processing andother low-end, nonvoice work. For low-end voice work (such as call centers), this goes up to $11 per hour. On the other hand, $22 per hour is forhigher-end work like investment banking research, intellectual propertyresearch, etc.

In either case, Indian companies typically charge for 2,050 to 2,100 workinghours per year per full-time-equivalent (FTE), although an average FTE in Indiais currently working 2,300 hours, which is the same as in South Korea (AlokAggarwal of Evalueserve, private communication with the author, August 15,2005). A significant component of unit cost is labor. Table 2 puts labor cost differences in perspective. At the low end of the skill spectrum (the first three rowsof occupations in table 2), India is likely to remain competitive for the foreseeable future. At the higher end of the spectrum (the last three rows), India's competitive edge is likely to be eroded, with Indian wages rising relative to the U.S.wage. On the other hand, productivity and quality improvements that will mitigate, if not completely offset, cost increases are also taking place. Saxenian, ina private communication ofMay 5,2005, points out that in interviews Indian ITprofessionals informed her of "the process and quality improvement in thelargest Indian firms (TCS, Wipro, Infosys, etc.), especially in the period since


24/39

T. N. Srinivasan 225Table 2. Hourly Wages for Selected Occupations, United States and India, 2002-03U.S. dollars

OccupationHourly wage,United States

Source:BardhanandKroll (2003, table3).

Hourly wage,India

Telephone operator 12.57 Under 1.00Health record technologists/medical transcriptionists 13.17 1.50-2.00Payroll clerk 15.17 1.50-2.00Legal assistant/paralegal 17.86 6.00-8.00Accountant 23.35 6.00-15.00Financial researcher/analyst 33.00-35.00 6.00-15.00

2000 when substantially more work was shifted to India from theU.S., allowingfor the accumulation of skill and learning on the job." Her own research foundthat there are a "surprisingly large number of Indian firms that are CMM [capability maturity model, developed by the Software Engineering Institute atCarnegie Mellon University] Level 5 certified. There are none inChina at Level5 yet, and few even in the U.S."

Another interesting set of cost comparisons relates tomedical tourism. JaySolomon reported in the Wall Street Journal (April 26, 2004) that India's"Apollo [hospital] offers cardiac surgery for about $4,000, compared with atleast $30,000 in the U.S. Apollo's orthopedic surgeries cost $4,500, less thanone-fourth the U.S. price." John Lancaster reported in the Washington Post(October 21, 2004, p. A01) on a patient with a life-threatening heart conditionwho would have had to undergo surgery at a cost in the United States of$200,000; instead he flew toNew Delhi and had it done at Escorts Heart Institute and Research Centre. It cost him $10,000, including airfare and a side tripto the Taj Mahal. Not only are costs lower, but quality may be higher as well atIndia's private centers of excellence, such as Escorts. Lancaster quotes NareshTrehan (a former assistant professor atNew York University's Medical School)of the Escorts Centre as saying that the "death rate for coronary bypass patientsat Escorts is 0.8 percent. By contrast, the 1999 death rate for the same procedureatNew York-Presbyterian Hospital, where former president Bill Clinton recentlyunderwent bypass surgery, was 2.35 percent, according to a 2002 study by theNew York State Health Department."A third report, by Saritha Rai (New York Times, April 7, 2005) speaks of a

patient from England who needed a coronary bypass operation but would havehad towait six months to get it from British National Health Services. He traveled toWockhardt Hospital in Bangalore for the surgery following a chance


25/39

226 Brookings Trade Forum: 2005meeting with a businessman who had gone to India for surgery. His surgeonthere had trained inLondon, and the surgery cost $8,400, including travel.Moreover, according to the patient, his surgeon gave him his cell phone number andwas available twenty-four hours a day. He concluded that in the British HealthSystem "you are just a number, but here you are a person."Such stories are frequently reported in the U.S. media. As I noted earlier,100,000-150,000 foreigners currently visit India formedical treatment annually.A report by McKinsey & Co. projects a revenue of $2.3 billion by 2012 frommedical tourism to India. It is not out of the realm of possibility that India could

go beyond offering inexpensive but high-quality surgery at hospitals and developas a destination for the elderlyto live out their retirement years in a warmer climate and with better health care than they could obtain in the United States or

Europe.Although the prospects for substantial growth in the ITES/IT sector, as wellas in in situ services such asmedical tourism, are very bright, realistically speak

ing there are several constraints besides a potential manpower shortage thatcould preclude their full realization. Reliable electric power, efficient and inexpensive telecommunications, and access to venture capital are essential infrastructures for the IT sector. Although telecommunications infrastructure hasvastly improved, as noted earlier, there are still some unresolved issues relatingto the authority of the regulatory agency (Telecommunications Authority ofIndia, TRAI) vis- -vis the Department of Telecommunications and the stateowned providers. The electric power situation continues to be abysmal. In fact,the large IT firms, like other large enterprises, have had to invest in their owncaptive power generation facilities. To the extent that the unit cost of power fromsmall-scale captive plants is much higher than it would be from an efficientlarge-scale utility, the failure of India's public power system adds an avoidablecost to doing business and dampens the competitiveness of its IT sector.

Narayana Murthy, the CEO of India's leading IT firm, Infosys, and SandeepRaju of the same firm pointed out in 2002:

Efficient commercialization of cutting-edge output from research labs,entrepreneurship forums at universities, highly efficient alumni networks,close links between leaders in academia and business, risk appetites ofventure capitalists, synergies between science/engineering schools andbusiness schools, collaborative research among universities, keiretsusbringing together businesses and venture capitalists, angels with the willingness to nurture talent, the abundance of forums where youngsters may

put forth their ideas and interact with industry leaders, opportunities for


26/39

T. N. Srinivasan 227collective learning all these are differentiators that put theValley severalnotches above other hi-tech habitats. In sum, Silicon Valley operates in avibrant market economy that reveres innovation.

That Bangalore entrepreneur, on the other hand, does not have easy access to all these resources. However, itmust be borne in mind that theinformation revolution is a fairly recent phenomenon in Bangalore.(Murthy and Raju 2002, p. 201).

Things have improved substantially since they wrote. The venture capital supplyhas increased, and some of the networks they mention are beginning to emerge.But significant close links between academia and business are yet to be forged.

Young workers in the IT industry are conscious of their market value, somuch so that turnover of workers in the ITES sector, particularly in smaller firmsoperating at the lower end of the quality spectrum, is high. In call centers, annualturnover is reported "to exceed 50 percent. High staff turnover is reported evenamong the more established, employee-friendly IT companies, some of whomoffer stock options and residential accommodations to entice employees to stayon" (Chithelen 2004, p. 1023). High turnover indicates an excess demand and

makes itmoreexpensive

for Indian firms tomaintain andimprove

their competitiveness and quality of service.23 Although India's labor force is very large,and more workers would like to acquire the skills to enter the IT sector, settingup training facilities would be costly and involve years of planning and imple

mentation. Chithelen notes that the explosive growth in BPO demand hasattracted new entrants to the business, and the resulting competition is reportedto have bid down fees from $20 per programming hour for U.S. entrants currently from over $60 in 2000. He fears that greater competition among vendors,some of whom are aggressive but inexperienced

new entrants, comingon

top oflabor supply constraints, could compound the decline in quality of service.India's labor and bankruptcy laws could be counterproductive in the IT sector, as they are in other sectors of the economy. A report in 2000 by the Subject

Group of Knowledge-Based Industries in the Prime Minister's Council recommended exempting the IT sector from some of the draconian provisions of labor

laws. Whether it is wise to exempt one sector from a dysfunctional law ratherthan repealing it is arguable. In any case, political support for a repeal is not there

23. Kanwal Rekhi points out in his private communication that the high turnover in the ITESsector is in the nature of the beast. This industry essentially employs youngsters who do not consider it a career. Many of them go on to higher learning. He cites the increase of Indian studentsinU.S. universities over the past several years as evidence of that.


27/39

228 Brookings Trade Forum: 2005yet. However, some de facto exemptions do exist. For example, in ITES, statesoften exempt call centers from working-hour restrictions, allowing women towork at night. Also, it is likely that programmers in large firms are not subject tothe same provisions as industrial workers.24

Moving away from domestic to external constraints, I have already mentioned the protectionist backlash against outsourcing in the United States andelsewhere. Apart from this, the outcome of negotiations on services in the DohaRound of world trade talks is also important. In the parlance of the GeneralAgreement on Trade in Services (GATS), there are four modes of services trade.From the perspective of outsourcing and trade in ITES/IT services more generally, the two modes that are particularly relevant for India are mode 1,whichcovers outsourcing that is, the supply of a service from the territory of onemember of theWTO to the territory of another member without movement ofthe use and provider of the service from where they are located; and mode Athat is, trade by a service supplier of one member, through the presence of natural persons of a member in the territory of any other member. In plain language, mode 4 involves temporary migration of labor from the territory of one

member to that of another. Members undertake commitments under each modeof supply. Thus far, members have made

most cross-border commitments formode 3, relating to foreign establishment. Commitments for mode 1 are muchnarrower and more limited, with a range of restrictions involving nationality,residency, authorization, and local authentication requirements. Commitmentson mode 4, perhaps themost relevant mode for most developing countries, arethe fewest and most restrictive. Many of the IT professionals from India in theUnited States have been admitted to the United States as temporary immigrantsunder H-1B visas. The annual number of such visas to be issued is determinedby Congress,

in part on the basis of market conditions for labor with the requisite skills and in response to lobbying. It is to be hoped that before theWTOministerial meeting inHong Kong inDecember 2005 the lacunae inGATS willbe addressed.

India is not the only country with a pool of English-speaking workers available for employment in the ITES/IT sector. Other countries with such populations include Bangladesh, Ireland, Pakistan, Sri Lanka, and the Philippines.

Except in Bangladesh, the wage costs are higher than India's in the other countries. The ability to speak English can, of course, be acquired, and as such, potential future competition for India from countries currently without a significantpool of English-speaking workers cannot be ruled out. Prominent among such

24.1 thank Nirvikar Singh for pointing this out.


28/39

T. N. Srinivasan 229countries is China. Yahya (2002) notes that there are two competing schools ofthought among Indian policymakers about China's efforts to expand its softwaresector: "One school believes that China is a serious competitor and that Indiashould not assist its progress in any way.... The other school argues that Indiahas a lead of two to three years over China and notes that India should use Chinaas amarket and collaborate with it" (Yahya 2002, pp. 114-15). I have alreadynoted that, given the various agreements signed and the press releases duringChinese premier Wen Jiabao's visit to India inApril 2005, the collaborationistschool seems to have won. In fact, asYahya points out, China's former premier,Zhu Rongji, during his visit to India in January 2002, also expressed the viewthat China and India could dominate the world IT market if they combinedforces. The report of the India-China Joint Study Group on ComprehensiveTrade and Economic Cooperation, presented to the prime ministers of the twocountries by their commerce and industries ministers during Wen Jiabao's visit,recommended the following:

Companies from India and China should continue to explore each other'smarkets. The two countries can use their core competencies in hardwareand software to increase their share of [the] world's trade and gain greateraccess in third country markets.

Industry association such as NASSCOM may closely interact with itscounterpart organization in China to promote co-operation in this sector.Both countries should work together to enforce copyright and reducepiracy. Moreover, the software enterprises of both countries can easilyadapt to the ever changing high-tech market and strengthen their status in[the] global market by having more joint research projects, enhancing the

exchange of technological personnel and cooperation in training.25The report also noted significant scope for collaboration between the two countries in the market for services in several areas, including health, accounting andauditing, education, finance, and advertising.

India's IT and ITES-BPO sectors have firmly established a global reputation,and the potential for sustaining their rapid growth is bright. The success of theindustry's premier organization, the National Association of Software and Service Companies (NASSCOM), is being emulated by associations in the pharmaceutical, computer hardware, and auto parts manufacturing industries and

25. "Report of the India-China Joint Study Group on Comprehensive Trade and Economic Cooperation" (www.hindu.com/thehindu/nic/0041/report.pdf [May 4, 2005]).


29/39

230 Brookings Trade Forum: 2005others. Importantly, like NASSCOM, they are succeeding not only in lobbyingbut also in raising standards and quality.26 The growth of the IT sector could contribute significantly to accelerating GDP growth and add a large number of wellpaid jobs. Faster GDP growth and the indirect employment created by IT sectorgrowth would also contribute to poverty reduction. There are, however, someserious domestic and external constraints that, if left unaddressed, could substantially diminish the realization of the potential growth.

Conclusion

The visible success of the IT sector raises two important questions. First, canIndia's future growth be IT-led, in the sense that the IT sector would not only bethe prime engine of growth but also, because of its increasing share of GDP,compensate for slower growth in the nonservice sectors such as agriculture andlarge-scale manufacturing? Second, to the extent that the success of the IT sector could be linked to policy reforms in telecommunications, for examplewould it broaden and strengthen political support for reforms in other sectors?In attempting to answer the first question it is useful to think about the backward and forward linkages in IT sector growth. Its backward linkages arise fromthe growth in demand for inputs of goods, services, and factors. In particular, thedemand will rise rapidly for labor with appropriate skills, for institutions that caneducate and train workers for employment in the IT sector, and for telecommunication services and power. Its forward linkages could be significant as well, ifother sectors of the economy invest in hardware and software to reap the productivity advantages of using IT services in their operations. Itwas noted earlierthat theMinistry of Finance projects that value added by the IT sector will reach7 percent by 2008, and at that rate a share of 25 percent is likely by 2020. Takentogether, the prospects for the IT sector's becoming the leading sector of theeconomy in the next decade or so are bright.

However, accelerating the rate of GDP growth to 8 percent or more per yearand sustaining it for several decades is a necessary, though not sufficient, condition for achieving the overarching objective of India's development, namely, theeradication of poverty. As is well known, a large majority of India's populationis rural, and more that half of the country's labor force still depends on agriculture and informal sector employment for a livelihood. And among the states

26. Kanwal Rekhi points this out and rightly emphasizes that such quality consciousness bodeswell for the future of Indian industry.


30/39

T. N. Srinivasan 231there is a significant variation since 1980 in economic performance, asmeasuredby growth of state domestic product. The IT sector is concentrated in the citiesof only a few states. Although the IT sector's spectacular past and likely futuregrowth will almost surely help to accelerate aggregate growth, translating fastergrowth into more rapid eradication of poverty would require widening, deepening, and accelerating economic reforms and liberalization.

The response to the second question, whether the prospects for bringing aboutthe required reforms are likely to be enhanced by the contribution of pastreforms to the visible success of the IT sector, is a qualified yes. The reasons forqualification are many. First, the link between reforms and success of the ITsector is not clearly seen even by reform-minded politicians. Second, a vast

majority of the population, particularly those rural areas, has yet to experiencethe benefits of efficient and inexpensive IT services in production and consumption activities, in part because IT services have not yet reached this population. Although this is changing, it is not changing rapidly enough to affect alarge share of the population. Third, although there is no political pressure toreverse the reforms enacted thus far, it is evident that the remaining items of thereform agenda to be adopted would require persuasion of and bargaining withthe parties not in the ruling coalition and its allies. Unlike in China, with itsauthoritarian, single-party government, success in this effort of persuasion inthe competitive democratic polity of India requires foresighted leadership andthe commitment of all parties. Just as the evident success of early agriculturalreforms in China and the participation of a large share of the population in thefruits of its success created a constituency for later reforms, one can expect asimilar effect in India once the benefits of IT success, and reforms more broadly,diffuse to the larger Indian population. It is encouraging and augurs well for thefuture that no political party (except perhaps the unreconstructed Stalinist elements of the left) is demanding a reversal of the reforms already enacted, and thedifferences among parties are more on the pace and sequencing of furtherreforms than on their content.


31/39

Commentand Discussion

Anne Krueger: As always, T. N. Srinivasan has provided an excellent analysisof the Indian economy's performance this time of the role of ITES (information-technology-enabled services) in past and prospective economic growth.His analysis of the growth of the IT sector ismasterly, and I have only a fewcomments on it. Iwill then focus on the insights that the experience of the ITsector provides for Indian economic policy and growth more broadly.Turning first to the IT sector, its performance has been spectacular by anystandard, especially in contrast to the rather sluggish performance of manyIndian economic activities. But it should be noted that there are several uniquecharacteristics of the IT sector thatmay have enabled it to grow so rapidly. Firstand foremost, IT is less heavily dependent on infrastructure thanmost industriesare. Srinivasan notes that twenty-five different government rules had to bechanged or removed in order to set up the first earth station in Bangalore in1986. But the fact is that the industry could rely on an earth link and avoid manyof the cumbersome aspects of Indian infrastructure: it hardly needed Indianroads or railroads, telecommunications (minimal as they then were), or Indianports. For many other industries, rules would have had to be altered and infrastructure and other bottlenecks removed. While the IT sector had to live with thesame constraints regarding other aspects of infrastructure as other industries, theeffect on their cost was arguably considerably less.

A significant feature of the IT sector is that most of the major firms havecampuses inBangalore and a few other cities, and these campuses are virtuallyself-sufficient. They have their own generators and do not depend on public provision of power. Company-owned buses even take people to and from work so

232


32/39

T. N. Srinivasan 233they don't have to rely on public transportation. Indeed, in Bangalore, some ofthe large firms are concerned that they may be unable to sustain their rapidgrowth because, as their employment increases, road congestion will be toogreat to absorb additional buses. The IT firms perceive the need to fight with thelocal authorities for capacity expansion for virtually every publicly providedurban service for which private investment cannot substitute.Infrastructure was less of a constraint for IT, but another factor was importantas well. The IT sector was "encouraged," as Srinivasan notes, but mostly byremoving the disadvantages that other industries have. The sector was "discriminated for" in the sense that it did not suffer the disadvantages the governmentimposes. For one thing, the industry was new, and in a sense it outran the government by growing rapidly before regulations could be put in place.

But, as Srinivasan also notes (all toomodestly, since he had a significant rolein it), the telecommunications reforms of the 1990s and later were highly significant. The IT sector probably could not have grown as rapidly as it did in theabsence of those changes. One can only wonder what industry or industrieswould experience comparably rapid growth if the transport, or the labormarket,or the power, bottlenecks, and regulations were removed for other sectors of theeconomy.One final comment on the IT sector's growth prospects. Srinivasan has a tableon wage differentials and notes that wages are very low by international standards. The relevant comparison should, of course, be unit labor costs, and a comparison there would be highly worthwhile. During the NAFTA debate in theearly 1990s, for example, much was made of the fact that average factory wagesin theUnited States were some ten times the average Mexican factory wage. Butonce the calculation of unit labor costs was undertaken, itwas found not surprisingly that unit labor costs were quite similar, and indeed several percentage points lower in the United States than inMexico. Clearly, there is greatscope for productivity improvement in India, in IT and elsewhere, and that canenable rising wages and sustained economic growth. Moreover, one would haveto guess that inmany IT services (where the physical capital input is very low)unit labor costs are significantly lower in India than in themajor industrial countries and that, for that reason, there is some scope for real compensationincreases in India in the context of rapid IT expansion.

But Iwant to focus on overall Indian growth. A first point relates to the excellent Indian Institutes of Technology, which have provided a steady flow ofworld-class engineers since they were first set up in the late 1950s. When theywere established, itwas in the belief that India had a "shortage" of e

Documents

Technology Enabled Services