Beyond Outsourcing :
Sustainable Economic Growth in India
Marjorie Rosenthal
May 15, 2004
The recent surge in exports of information technology consulting and business processing services has had a major impact on India’s economy. Indian businesses have proven to the U.S. and to Europe that their work force is capable of providing seamless, reliable, timely, high-quality services in this sector. While the popularity of outsourcing to India among Western companies is encouraging for the country’s development, the impact has been largely sector specific.
The U.S. news media portrays the image that while India is thriving, the U.S. is suffering enormous job loss; however, after a short visit to the country it is clear that this recent improvement is a relatively small segment of the Indian economy. Further attention to India’s domestic market is critical for the country to achieve long-term sustainable sucess.
This paper attempts to evaluate the impact the outsourcing trend has had on the economy, other hurdles facing economic progress, and to outline several key potential next steps on the path to sustainable development.
Outsourcing’s Impact on the Economy
GDP Growth
2003 was a tremendous year for India. The GDP growth rate reached an impressive 8.1% compared to the prior four years: 4.6% in 2002, 5.1% in 2001, 3.9% in 2000 and 7.1% in 1999. While agriculture and industrials contributed 23% and 26% respectively, the services sector contributed approximately 50% of the GDP.[1] Within services, the information technology (IT) sector drove India’s growth. A steady trend since the early 1990s, the IT sector has grown on average 46% per year since 1993.[2] However, this growth has not, until recently, attracted the attention of the global news media. Despite the recent recession in the U.S. and the resulting off-shoring backlash, the Indian services sector (largely IT) is expected to grow at approximately 9% in the next two years.[3]
Employment Opportunities
The IT boom has also complemented the country’s heavy emphasis on technical training and higher education. This has contributed positively to the employment rate of Indian college graduates. Wipro and Infosys, the two major Indian firms in this space currently employ over 40,000 people.[4] There are also over 70 foreign firms with operations in India. These firms include such widely-known American technology companies as Accenture (~5% of the firm’s employees based in India), Cisco (~6%), and Oracle (~7%). Additionally many foreign firms established in-house business processes operations in India including: American Express, AXA, Barclays, Ford, British Telecom, GE Capital, and Prudential. It is estimated that multinationals employ over 80,000 people in India of which a majority are highly educated Indian nationals instead of U.S. or European expatriates. Moreover, these same firms have plans to expand significantly within the next 5 years.[5]
New Middle Class
India’s technology growth has resulted in the emergence of a new middle class. This new population with significant buying power is a positive sign for the economy. Private consumption is rising, retail sales have increased and productivity has improved. For example, sales of automobiles increased by over 30% in the last year and new mobile phone sales doubled.[6]
Increased Entrepreneurial Spirit
Overall, the trend in Western IT/BPO outsourcing has been the main driver of growth in terms of output and employment as well as productivity improvements for the Indian economy. The success of firms started by daring entrepreneurs like Mr. Murthy of Infosys and led by bold visionaries like Mr. Premji of Wipro has encouraged others to start their own firms. Currently, there are many BPOs trying to ride the off-shoring wave. This phenomenon is much like the Dot Com boom in the late 1990s in the U.S.
While the rapid BPO proliferation may face consolidation long-term, the entrepreneurial spirit is not likely to fade as quickly. Belief that one can venture into one’s own business is crucial for the continued development of an economy. Additionally, it is clear that the technology firms have created an intense and productive culture reminiscent of a Silicon Valley startup. I recall an American manager from Wipro commenting on his uncertainty of whether he could keep pace with his engineering team in India. Additionally, one of the employees at GE’s Jack Welch R&D Center in Bangalore conveyed that most researchers in India “live to work” rather than “work to live”. Unlike the traditional India conglomerates and public sector, there is a definite intensity and energy within these technology firms that will benefit long-term economic growth.
Current Development Issues Facing India
Despite the increased GDP growth and the aggressive foreign investment, India still faces some major hurdles on its path to sustainable economic development. This section briefly addresses three of the most prominent obstacles: income disparity, poor infrastructure, and underdeveloped capital markets. The following is meant to be a brief summary of each and is by no means an exhaustive discussion.
Income Disparity
Even though the economy has grown at an excellent rate, and poverty has been reduced by approximately 10%, one quarter of India’s 1.05 billion people still live below the poverty line.[7] The majority of the population “lives in villages with a population of less than 5,000”[8] and is highly dependant on the agriculture sector. Additionally, the rapidly growing private sector firms are concentrated around Mumbai, Delhi, Bangalore, and Chennai. “In contrast large parts of India’s most populous areas in the north and east …are particularly poor and underdeveloped.”[9] When visiting several sites of major Indian and foreign firms, the juxtaposition of the shanty-towns outside the front gate of the development clearly illustrated this income disparity.
Poor Infrastructure
Due to the lacking infrastructure, successful firms have become almost entirely self-sufficient with their own generators, satellites and roads to name a few. Also, it is no surprise that the thriving export sector, IT, does not rely on the ports for shipping their goods. The emergence of such successful enterprises proves that Indian firms are agile and innovative; however, drastic improvements to the country’s infrastructure are required before the domestic market can flourish in the same way the IT export sector has.
Underdeveloped Capital Markets
The Indian government has made progress in modernizing the capital markets with the recent establishment of a credit bureau, a standardized appraisal system, an improvement in lender rights with respect to default, and a more robust bankruptcy framework. However, the financial markets are not yet able to allocate capital efficiently. This inefficiency is especially apparent in the small and medium-sized enterprise (SMEs) segment. In particular, the banking system does “not have the necessary credit information on SMEs” and “does not have modern tools of credit scoring for SMEs.”[10] Additionally, since most SMEs lack collateral or proper documentation on collateral needed to secure loans, banks generally have a highly negative view on SMEs lending.[11] This inefficiency in the capital markets is stifling to the development of the domestic market, as the SMEs “have the greatest potential to provide high-wage employment for the 70 percent of the labor still working in agriculture.”[12]
Next Steps for Sustainable Economic Development
While the increased demand for IT exports has had a positive impact on the country, its effect has been isolated to specific regions and segments of the labor force. Although a vibrant industry with good growth prospects, it has only directly benefited roughly 0.01% of India’s population. It can be argued that the success in the IT sector will spill over into the domestic market as middle class buying power increases, but to sustain this, the domestic market needs to improve and offer better quality products and services to meet middle class demand.
Moreover, the most critical problem facing India is its 25% poverty rate. The Indian government’s tenth five year plan aims to reduce this to 10%; to meet this, the economy must grow at an annual rate of 8% for the next ten years.[13] As stated above, the SME sector has the greatest chance of making an impact on the entire economy. While not a simple task and not the only areas in need of reform, improving the country’s capital markets and infrastructure will help the domestic market flourish and lessen income disparity.
Lastly, as stated aptly by one reporter: “If a choice between changing global mindsets towards outsourcing from India and changing Indian mindsets towards markets has to be exercised, the latter is the more valuable option.”[14] India has rich natural resources and a highly educated work force with an untapped entrepreneurial spirit. Reforms in the capital markets and improvements in infrastructure will provide greater opportunities and help change to mindset of the population. A change in the mindset could add approximately $60 billion in annual purchasing power. This is approximately three times greater than the value created by the BPO exports.[15]
Conclusion
While the IT/BPO export trend has helped India grow in the last decade, the domestic market still lags behind. Lessening the income gap will help address the poverty issue. A thriving SMEs sector would have a wide spread impact on the economy and help change the mindsets of the general population by giving opportunity and foster entrepreneurship. India has made great progress in sustainable development, but more work is needed to achieve its goals.
[1] The Economist Intelligence Unit, India Country Report March 2004.
[2] The Economist Intelligence Unit, India Country Profile 2003.
[3] Economist Intelligence Unit – ViewsWire, 2 March 2004.
[4] J.P. Morgan and Morgan Stanley Equity Research, April 2004.
[5] A. Narayan and A. Soni, JM Morgan Stanley Equity Research, December 2003.
[6]Economist Intelligence Unit – ViewsWire, 2 March 2004.
[7] The World Fact Book, 2002.
[8] The Economist Intelligence Unit, Country Profile 2003.
[9] The Economist Intelligence Unit, Country Profile 2003.
[10] P. Basu, World Bank Report No. AB756 SME Financing & Development.
[11] Ibid.
[12] Ibid.
[13] Ibid.
[14] G. Ramachandran, The Hindu Business Line, May 13, 2004.
[15] Ibid.