Revisiting India’s Outsourcing Boom

C P Chandrasekhar

OFFSHORING, or the outsourcing of services by developed country firms to captive units or independent suppliers in developing countries has for some time now been a source for controversy in the developed countries, especially the US. Arguments that such offshoring involves not just the transfer abroad of new job opportunities that would have arisen in the developed countries, but the loss of existing jobs in the US to offshore locations abound. They derive their strength from reports that specific corporations have been reducing or plan to reduce their workforce in developed-country locations, even while expanding them in developing countries such as India. In the event, calls for protectionist responses that limit and roll-back the offshoring of services have increased dominate the US debate. On the other hand, firms clamouring to retain their tax holidays despite booming profits present outsourcing as the route to India’s economic salvation.

The recently released Annual Trade Report of the WTO  provides an occasion to revisit these arguments, because a special chapter in the report focuses on offshoring of IT services and argues that: (i) the extent of net offshoring is exaggerated; and (ii) that to the extent that offshoring occurs its negative effects on the source country and positive benefits for the host country have also both been exaggerated.

BENEFITS EXAGGERATED

The WTO’s argument begins with pointing to the extremely shaky and predominantly private sector generated database on the phenomenon. In some cases as in India, even official information as available in the balance of payments statistics is collected and collated by a private body --- in this case the National Association of Software and Services Companies (NASSCOM).

Discrepancies in the data arise with regard to the size of the global IT services market itself, besides its outsourced component. For example, the European Information Technology Observatory (EITO) estimates the size of the global IT services market, excluding business process (BP) services, at 710 billion dollar (€591 billion) in 2003. On the other hand, the OECD estimates the size of the global market for outsourced IT and business process services to be close to 260 billion dollar in 2001. Taking into account reasonable estimates of exchange rate changes and market growth, this makes the EITO estimate much larger than that of the OECD’s, despite its narrower coverage. Further, Gartner estimates that out of a total of 663 billion dollar of software and IT services expenditure in 2003, around 322 billion dollar was outsourced. Though closer to the OECD’s outsourced services estimate, even this appears higher than the OECD’s broader estimate.

Similar discrepancies are seen in estimates of offshoring as well. The OECD places the value of offshored IT and business service activities at 32 billion dollar in 2003, representing 12.3 per cent of the global IT market. McKinsey, on the other hand, estimates that US companies offshored IT and business process (BP) services worth 26 billion dollar to 12 major markets in 2001. The 12 markets exclude major EU markets and therefore the figure somewhat underestimates the global offshoring of US companies worldwide Even if we ignore this, since the share of US companies in global offshoring activities is estimated at 70 per cent, this suggests that the global value for all offshored IT and BP services was at 35 billion dollar in 2001, higher than the OECD’s 2003 value.

While recognising the private nature of the sources of these statistics, the WTO, for lack of an alternative, places IT and software expenditure worldwide in the order of 650 to 710 billion dollar in 2003. Total outsourced IT services (excluding software) are paced at around 285 billion dollar. Offshored IT and BP services are estimated to have been in the order of 40 to 45 billion dollar in 2003. This places offshored IT and BP services at just 2.5 per cent of world commercial services exports, valued at 1,800 billion dollar and at a meagre 0.125 per cent of world GDP valued at 36,000 billion dollar. No one can claim that this is enough to disrupt economic activity and employment in the developed countries.

The point is that even of this, the share offshored to captive units is quite substantial according to available estimates. According to the WTO: “Many surveys confirm that at present, most offshoring takes the form of captive offshoring. This view is supported by data on US IT services imports. In 2003, affiliated trade (or form US subsidiaries or joint ventures abroad) accounted for 63 per cent of US computer and information services imports, and for 77 per cent of US imports of other business, professional and technical services, a proxy for business process services.”

SOFTWARE EXPORTS

However, the WTO notes, this conflicts with the NASSCOM view that India’s software exports of 2003-04 are provided largely by Indian-owned companies. This is the first of the puzzles offered by the Indian IT industry that needs to be unravelled. The second is the discrepancy between the volume of IT and IT-enabled services exports to the US as reflected in the Balance of Payments (BoP) statistics from India and the US. According to the Reserve Bank of India, India’s “software” exports amounted to 11.3 billion dollar in 2003. Taking NASSCOM’s estmates that around 60 per cent of this went to the US market, software exports to the US in 2003 works out to be 6.77 billion dollar according to official BoP statistics.

Turning to the US, official BoP statistics indicate that US imports of IT services through unaffiliated agents from India amounted to 330 million dollar in 2003. The same source reveals that the share of unaffiliated trade in total US IT imports stood at 36.5 per cent. Assuming that the same figure holds for US bilateral trade with India, the (estimated) imports of IT services from India works out to just 900 million dollar. US imports of all services (including affiliated trade) from India, without transport, travel and royalties and license fees, amounted to 1,139 million dollar in 2003. This represents the upper limit for total US imports of from India, making the 900 million dollar figure for IT services appear reasonable.

How do we reconcile this major difference in the numbers (6.77 billion dollar and 0.9 billion dollar) involved? One of course is to take account of the possible mis-categorisation of other business services as software services. BoP data on “business services” are reported under two heads: ‘computer and information services’ (CIS) and ‘other business services’. However, national statistics do not reflect a uniform principle with regard to the allocation of services trade between these two categories. In particular, in India a range of IT-enabled services, such as call centres and medical transcription services, are reported along with export of software services. For example, the Reserve Bank of India’s (RBI) Annual Report 2004 shows that Indian “software” exports worth 12.2 billion dollar in 2003-04 include IT-enabled services amounting to 3.6 billion dollar.

EXPORTS TO US INFLATED

But assuming that the figures for India’s exports of “software” to the US is inflated by the same proportion, we should expect that software exports to the US would have amounted to 5.75 billion dollar. This still is way above the US BoP figure. To explain this difference the WTO examines the possibility that what are paid as “salaries” to India IT-workers on short term H-1B visas gets reported as software exports. It is true that the NASSCOM reports that a large share of India’s “software exports” is delivered “onsite”. However, “onsite” delivery by Indians employed abroad can be treated as an export from India only as long as these employees have not been staying abroad for more than one year. If they do they should definitionally be considered residents of the host country.  Thereafter, the earnings of these employees are no longer counted in the BOP statistics, although they might reappear later in the form of worker remittances. Unfortunately, information on the number of Indian IT specialists and beneficiaries of H-1B visas who had already worked in the United States for more than one year is not easily available.

So the WTO supports the view that misallocation of salary payments is possibly what explains the discrepancy between US and Indian BoP statistics on the basis of the following argument.  Taking the annual approval of beneficiaries of H-1B visas, the WTO estimates that their number could have been close to 80,000 in 2003. If this number is multiplied by the average annual earnings (about 60,000 dollar) of these workers, their total earnings turns out to be 4.8 billion dollar over the year, which tallies closely with the discrepancy in the statistics provided by the two countries. So the exclusion of those who have been there for more than a year could possibly explain a large part of the discrepancy.

It is still too early to judge whether the WTO has arrived at a correct conjecture. But if that conjecture were true it does have implications for the nature of India’s software success. To start with, it does suggest that onsite delivery is still an extremely important component of India’s software success. Further, it speaks for the nature of the software services provided by Indian firms. The argument is that Indian companies are earning substantial sums based on a per-hour or per-manday fee charged to firms, which use imported workers to customise software, solve problems or develop specific applications. Since these workers are paid a salary in India and an allowance while they are abroad, the consultancy fee paid by the importing firm is the revenue of the exporting firm and the difference between the per employee fee and the cost per employee is the surplus accruing to the exporting firm.

It has been argued that body-shopping of this kind is representative of activities that are at the lower end of the software services spectrum. This has implications for both the quality and sustainability of India’s IT export boom. India today dominates the global market for outsourced software and IT-enabled services. NASCCOM quotes an estimate according to which India today accounts for 44 per cent of the global outsourcing market. This ratio goes up to 55 per cent if only the ITeS-BPO segment is considered. If current growth rates are to persist either the global market would have to grow at that rate with a stable Indian share or the industry would have to increase its share of the global market over time. That is indeed a touch difficult.

SERVICES IN EXPORT REVENUES

Further, since body-shopping and the ITeS-BPO sector accounts for a rising share of total services export revenues, India’s dependence on the less skill-intensive segments of the software and IT-services sector is overwhelming. This makes it even more difficult to maintain market shares, especially without a substantial drop in revenues per employee, since competitors are more easily generated.

Finally, even if India’s share of outsourcing revenues remains high, the net benefits of this are still unclear because of the dominance of a few firms and a substantial share for captive offshore outsourcing by international firms in the ITeS-BPO sector. According to NASSCOM figures, in 2003-04 the top 20 software and IT services exporters accounted for as much as 61 per cent of total export revenues. And captive ITeS-BPO providers accounted for as much as 65 per cent of the value of ITeS contracts outsourced to India. This kind of concentration not only makes the linkage effects of the growth of the industry less significant, it also has adverse implications for the net foreign exchange earning of the sector after taking into account repatriation of profits and other payments abroad.

INEQUALISING GROWTH

It must be noted that the absolute employment contribution of the software and IT services sector makes its position within the Indian economy that of an enclave. Even at just over a million, the number of workers in software and IT services amounts to just one quarter of one per cent of all workers in India as per the 2001 Census, or one-third of one per cent of all main workers in 2001 or two-thirds of one per cent of all workers outside agriculture and household industry. This suggests that a sector whose presence in terms of its contribution to GDP and its contribution to India’s currently comfortable balance of payments position is indeed signficant, cannot make much of a direct difference to a substantial section of India’s population. Hence an excessive dependence on this sector for growth at the margin may be inequalising, a possibility that the WTO also recognises.