Why a US ban on offshore outsourcing is the best possible thing for India!

Perhaps I am imagining this, but the anti-outsourcing anti-free-trade crowd seems to be contorting the results of the recent election into an endorsement of their anti-free-trade beliefs. Perhaps they are right and perhaps the new Congress will be far more opposed to free-trade. In fact, today someone asked me, “So what will India do if we ban offshoring?” I would have just laughed if it wasn’t for the fact that I have been asked this question before. So, even though the question is somewhat unrealistic, let’s imagine a situation where the US magically manages to ban offshore outsourcing. What would this imply for India?

Companies like Microsoft, Oracle and others employ thousands of engineers in India. These highly trained engineers develop the code that gets shipped in software like Microsoft Vista. Microsoft’s profit margins on software such as Vista may be as high as 80%. Thus, the Indian engineer and the Indian economy capture a miniscule proportion of the value partially created by the engineer. The majority of the value flows into the US economy in the form of profits earned by Microsoft on the software partially created in India. McKinsey Global Institute (MGI) actually reported on this extensively in their “Offshoring: Is It a Win-Win Game?” report accessible at: www.mckinsey.com/mgi/publications/win_win_game.asp

Of the $1.45 - $1.47 of value MGI estimates is created globally from every dollar spend a domestic company chooses to divert abroad, the U.S. captures $1.12 - $1.14 while the receiving country captures on average 33 cents. In other words, the U.S. captures 78 percent of the total value [created when an activity is offshored].

So what happens when the US magically bans offshoring? Does the Indian software engineer go and start plowing the rice fields? Not very likely. It is far more likely that some senior manager in Microsoft India would reorganize the former employees of this now defunct organization into a new company called Microsoft Lite. These guys would then churn out similar software, but would be forced to move up the stack and sell high-margin packaged software rather than low-margin IT outsourcing. The cost advantage would however not disappear. Imagine new Indian companies churning out software pretty similar to those produced by US companies, but at a 30% lower price. There might be some quality differences, but these would be minor relative to the price advantage. All of a sudden, the revenues of the affected US companies would shrink and they would be forced to fire the exact same people they recently hired to replace the now illegal outsourced engineers.

The new Indian companies on the other hand would receive a much needed kick in the butt. Indians would no longer have the luxury of being satisfied with safe IT outsourcing jobs. They would be forced to learn how to compete in the global market for finished software. This is a much more high-risk market than IT outsourcing and for a few years these new Indian companies would go through many trials and tribulations. Eventually though, because necessity is the mother of invention, they would be forced to figure out how to compete in the packaged software market. Indian immigrants in America have started hundreds of successful software companies; there is no reason to believe they can’t eventually do the same in their home country. All of a sudden, the US offshoring ban would have kicked the Indian IT industry several rungs up the evolutionary ladder. India would start capturing tens of billions of dollars of packaged software profits instead of the billions of IT outsourcing revenues it is currently earning. To the Americans who sacrificed tens of billions of dollars of GDP to give India the much-needed boost by banning offshoring, all the Indians would say is, “Thank you America!”