The rise of Indian software industry

David Ricardo has developed theory of Comparative Advantage. Which was later developed by Heckscher-Olin. They all argued that all countries have different factor endowments of labour, land and capital inputs. Therefore, Countries should be able to specialise in and export products that they can efficiently produce. Comparative advantage says that international trade happens when there are differences in the price of production. (Hill Charles W. 2002).

Ricardo particularly argued that, the gains of specialisation depend on comparative advantage. World production can always be increased if trade takes place between countries, which have different relative efficiencies in the production of any goods or services. If each concentrates on those commodities in which it is relatively more efficient, or relatively less inefficient, a gain is there for the taking. (Hill Charles W. 2002).

Without comparative advantage, there is no reallocation of resources within countries that will increase total world production. (Hill Charles W. 2002).

Comparative Advantage of Indian software industry

The rise of India’s software industry, in my opinion clearly explains major part of the theory of comparative advantage. On the first part according to the theory, India has been able to specialize in those goods (software) that it produces more efficiently and at the same time exports it to the countries were software is produced less efficiently. (E.g. US, Europe and Australia). From the viewpoint of the developed countries, (which outsource) are importing goods, which there produce less efficiently. Therefore, this theory mostly focuses on the development of the global economy, where every country can gain benefits in trade.

The Economic gain from trade

The theory of comparative advantage suggests that trade is a positive game in which all countries that participate realize economic gains. (Hill Charles W. 2002).

As in the case of India and U.S., according to Mc Kinsey projected of the year ago that India would generate $ 17 Billion in outsourcing revenues, employing 1.1 million by 2008. Which is huge economical rise for a country like India. This also translates into $ 60 Billion in benefits to the American economy arising from cost savings, new revenues, repatriated earnings and labor redeployment. Given the exponential growth experienced by the India based service centers over the past years, the revenues could reach $25 billion, corresponding to economic benefit to the global economy. This is indeed a phenomenal contribution to global GDP. (Source: India Today August 4, 2003).

Free trade

The basic message of the theory of comparative advantage is that potential work production is greater with unrestricted free trade than it is with restricted trade. (Hill Charles W. 2002).

The unrestricted free trade between the countries becomes a backbone for India and other countries outsourcing to it. Supported by information and telecommunication technologies, which made it possible to trade what has long been locked up within the national borders: skills, talent, ideas, and enterprise. I would say that the rise of Indian software industry provides a strong rationale for encouraging free trade. As both India and the customer countries are strongly benefited and could be a perfect example for Ricardo’s theory of comparative advantage in extending free trade argument.

Immobile resources

Resources do not always move easily from one economic activity to another. The process creates friction and human suffering too. While the theory predicts that the benefits of free trade outweigh the costs by significant margin, this is of no comfort to those who bear the costs. Accordingly, political opposition to the adoption of free trade regime typically comes from those whose jobs are most at risk. (Hill Charles W. 2002). In U.S., there have been several protests from the IT workers and the engineers against free trade, because this group has much loss form the free trade. Governments often ease the transition toward free trade by helping to retain those who lose their jobs as a result (Source: India Today August 4, 2003). The pain caused by the movement toward a free trade is short-term phenomenon, while the gains from the trade once that transition has been made are both significant and enduring. (Hill Charles W. 2002).

Diminishing returns

The theory says that, the more a country produces, at some point, will require more resources. (Diminishing returns to specialization). (Hill Charles W. 2002).

This becomes a challenge in the industry; the challenge is motivation and growth opportunities for employees. Matching an employee’s skills to the available work is a key management issue. As demand goes up and the level of opportunities for an information worker diminishes in a company, the attrition level goes up. Indian companies need to find a way to retain their employees. (Source: India Today August 4, 2003).

The key elements that affect the effective cost structure of remote processing facility are the calibre and increased productivity and low inflation are more sustainable for global competition.

Secondly, Indian companies need to understand the impact of their operations on India’s economy and manage the expectations of its key constituents.

Finally Indian companies need to enhance their comparative advantage in terms of productive labour pool by leveraging a few key factors. These include a large supply base that can withstand fluctuations in demand and ability to offer more value added services while maintaining quality.

(Source: India Today August 4, 2003)

Ricardo’s theory of comparative advantage identifies software as a product where India is an efficient producer and exports it to the country where it is less efficiently produced. In my opinion, this theory clearly satisfies and contributes a major portion in the rise of Indian software industry but more on the global economy.

Question 2

To what extent does Heckscher-Ohlin theory explain the rise of the Indian software industry?

Answer

Ricardo’s theory says that comparative advantage arises form differences in productivity. That is, whether India is more efficient than the developing countries, which outsource, depends on how productively it uses its resources.

Ricardo said labour productivity and argued that differences in labour productivity between nations underlie the notion of comparative advantage. (Hill Charles W. 2002).

Swedish economists Eli Hecksher and Bertil Ohlin put forward a different explanation of comparative advantage. They argued that comparative advantage arises from differences in national factor endowments.

(Hill Charles W. 2002).

Factor endowments

A nations position in factors of production such as skilled labour or the infrastructure necessary to compete in a given industry. Nations have varying factor endowments, and different factor endowments explain differences in factor costs. The more abundant a factor, the lower its cost.

(Hill Charles W. 2002).

The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors are locally scarce. (Hill Charles W. 2002).

Therefore, as in the case of India, the rise of software industry in respect of H-O theory is because of its abundant factor endowments. (Land, labour, capital and infrastructure.) Which I believe is the strongest reason behind the boom of the Indian software industry.

India’s factor endowments

1. Low cost labour

Low cost of quality programming labour, a well-trained Indian software engineer costs a fraction of a US engineer with the same skills. In India, an entry-level programmer’s salary ranges from $2 000- $5 000 per year compared with $50 000- $60 000 in the US. This makes a huge difference for the company which out sources to India.

2. Advanced telecommunication set-up

High-speed datacom links, there are about 500 in the country to connect Indian software companies to their customers worldwide.

3. Universal spread of the English language

All higher education in India is in English. India has the second-largest English speaking scientific manpower pool in the world behind the US.

4. Pragmatic governmental policies

The Indian government provides incentives for software companies geared towards exporting their software development abroad. These companies benefit from duty free hardware imports and tax holidays, among other things.

5. High growth of computer education

Indian institutions are producing 55 000 students a year. “Bridge programmes” provide computer and software education to professionals with other engineering and science degrees.

6. Software technology parks

Software Technology Parks of India is an autonomous organization which provides infrastructure assistance and communication links. These centres get duty free import, income tax exemptions, dedicated high-speed data communication links and single window government clearances.

The central government’s liberalisation policies are also set to continue and continued growth is predicted. The present cost advantage in terms of cheaper labour may gradually be eroded as salaries continue to increase.

However, the sheer volume of skilled Indian IT professionals available will continue to represent the single most valuable advantage for Western countries which are plagued with IT skills shortages and high costs.

(Source: www.btimes.co)

This theory shows that a particular factor of production is responsible for this efficiency. The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors are locally scarce.

I would say that this theory clearly explains the rise of the Indian software industry, because without efficient factor endowments a comparative advantage cannot be taken.

Question 3

Use Michael Porter’s diamond to analysis the rise of the Indian software industry. Does this analysis help explain the rise of software industry?

Answer

Michael Porter of Harvard business school speaks of four attributes as constituting the diamond. He argues that firms are most likely to succeed in industries segments where the diamond is most favourable. He also argues that the diamond is a mutually reinforcing system. The effect of one attribute is contingent on the state of others. (Hill Charles W. 2002).

1. Factor endowments: A nation’s position in factors of production such as skilled labour or the infrastructure necessary to compete in a given industry. (Hill Charles W. 2002).

In the case of India, it has abundant factor endowments, such as, low cost skilled labour, advanced communication infrastructure, technological know-how, universal spread of English language, and high growth of computer education. According to porter advanced factors such as these are the most significant for competitive advantage. Therefore, this attribute can be analysed for the rise of Indian software industries and can be said that India is on a competitive advantage basing on this factor.

2. Demand conditions: the nature of home demand for the industry product or service. (Hill Charles W. 2002).

Therefore, applying this factor to our case, I would say that the rise of software industry has nothing to do with the home demand.

3. Relating and supporting industries: the presence or absence of supplier industries and related industries that are internationally competitive. (Hill Charles W. 2002).

The related supported industries role is quite minimal, in my view the education industry and some government organizations provide strong support.

4. Firm Strategy, structure, and rivalry: the conditions governing how companies are created, organised, and managed and the nature of domestic rivalry. (Hill Charles W. 2002).

There is huge competition between local engineers, firms and contractors abroad. By which according to Porter, increases the competitiveness of the firms.

Chance

India has major chance events, as it is supported by several factor endowments benefits and creates a comparative advantage. This comparative advantage can reshape industry structure and provide the opportunity of a competitive advantage.

Government

The Indian government has assisted by providing both the educational system and interconnections to the global information network. Within the Indian software industry, there is competition for both local engineers and contracts from abroad.

Finally, in the previous question the Hecksher-Ohlin theory leaves us wondering why India has such an abundant supply of software engineers. And in this question, Porter’s theory helps explain why India was able to develop a software industry. India has a growing middle class that is well educated, with good skills in English, (factor endowments) and who are attracted to engineering due to the relatively high wages. The Indian government has assisted by providing both the educational system and interconnections to the global information network. Within the Indian software industry, there is competition for both local engineers and contracts from abroad. Other aspects of the Porter model, however, are not well supported, domestic demand conditions play no role, and that of related or supporting industries is minimal.

Therefore, in my opinion the Porters diamond may not help that much in analyzing the rise of Indian software industry as it is only supported by two of attributes in specific, but not all the four constituting in the diamond.

Question 4

Which of the above theories, comparative advantage, Hecksher-Ohlin, or Porter’s – gives the best explanation of the rise of the Indian software industry? Why?

The three theories build upon each other.

Comparative advantage identifies software as a product where India is an efficient producer and exports it to the country where is less efficiently produced. Comparative advantage says that international trade happens when there are differences in the price of production. This theory clearly satisfies and contributes a major portion in the rise of Indian software industry and more on the global economy. But it does not focus more on the factor endowments among countries, which happens to be the backbone for this efficiency and therefore in the rise of Indian software industry.

Hecksher-Ohlin shows that a particular factor of production is responsible for this efficiency. The Heckscher-Ohlin theory predicts that countries will export those goods that make intensive use of factors that are locally abundant, while importing goods that make intensive use of factors are locally scarce.

I would say that this theory clearly explains the rise of the Indian software industry, because without efficient factor endowments a comparative advantage cannot be taken.

Porter model identifies several variables that have contributed to development of this factor of production. In which some are lagging behind to satisfy it completely, like the local demand conditions and relative supporting industries. These two attributes have relatively less impact on the rise of the Indian software industry.

To conclude, While the Porter model gives the most complete explanation, it is perhaps a more complex model than required and aspects of the model would appear to have played very little role in the development of the industry. If parsimony were taken into consideration, the Hecksher-Ohlin theory would seem to provide the best explanation.

References

http://www.hindu.com/thehindu/biz/2002/03/14/stories/2002031400150100.htm

http://itfriend.mit.gov.in/adavantageindia/industrialprofile.asp

http://www.btimes.co.za/98/1004/tech/tech03.htm

http://www.outsource2india.com/why_outsource/articles/MacroeconomicsofOutsourcing2.pdf