Offshoring ≠ illegal immigration

I have been closely following the current immigration debate and I was disturbed to see illegal immigration and offshore outsourcing discussed in the same breath by many commentators. Let us not confuse the two: the first is illegal, the second is not only legal but in fact any limitations on outsourcing would probably run afoul of international free-trade agreements and could ruin the US economy.

It is amazing how shortsighted these opponents of outsourcing are. The United States counts for 12.06% of total world exports while China counts for 5.33% and India a miniscule 1.14%! [Data from “The Economist Pocket World in Figures” 2007 Edition] If the US initiates a trade war and disrupts the global trade environment it stands to lose more than 10 times as much as India. As I have written before, the last time the US turned protectionist, it slid into the Great Depression. Let us not repeat the same mistake again.

All this vilification of outsourced may even be completely counterfactual. Take a look at Robert Samuelson’s “What Offshoring Wave?” article in The Washington Post. He explains that only 4% of mass layoffs stemmed from offshoring. I must admit that there is a flaw in his argument: he is only looking at layoffs of 50 or more and it would have been much more interesting to look at all layoffs. However, there is no reason to believe smaller layoffs would have significantly different causes. Here are a few select quotes from Samuelson’s article:

For the United States, Kirkegaard examined a survey on "mass layoffs" from the Bureau of Labor Statistics to see how many stemmed from offshoring. The answer: 4 percent. That included both manufacturing and service jobs.

In 2004 and 2005, the BLS counted almost 1 million workers fired in layoffs of 50 or more. That isn't a huge number in a labor force of about 150 million. Moreover, most causes were domestic. The largest reason (accounting for about 25 percent) was "contract completion" -- a public works job done, a movie finished. Other big categories included "downsizing" (16 percent) and the combination of bankruptcy and "financial difficulty" (10 percent). Only about 12 percent of layoffs stemmed from "movement of work" -- a category that would include offshoring. But two-thirds of those moves were domestic.

It's true that offshoring doesn't measure the full impact of globalization on U.S. labor markets. That effect would also include trade and investment by multinational firms. Still, with the unemployment rate at 4.5 percent, it's clear that globalization hasn't crippled the U.S. job machine.

Losing a job is a wrenching experience for anyone, but the lesson here is that most job loss has local causes. The offshoring obsession reflects its novelty and the potential threat to white-collar jobs that seemed inherently safe from foreign competition. In our mind's eye, globalization is so powerful that it's sweeping everything before it. The reality is that, though globalization is increasingly important, it's still a weakling compared with the domestic economy. The antidote to job loss is job creation, and that depends decisively on national economic policies and conditions.

It's easy to blame all our economic anxieties and problems on globalization, because that makes foreigners and multinational companies responsible. Though satisfying, it will also be self-defeating if it diverts attention from fostering a healthy economy at home.

The secret weapon of the Chinese BPO industry

I have an ongoing bet with my COO Benny who happens to be Chinese. He believes that the Chinese Business Process Outsourcing (BPO) industry will eat India’s lunch in the next few years. I on the other hand have always been confident that Indian entrepreneurship and innovation will help Indian BPOs beat all competitors including the Chinese. Till recently, I never worried that I may actually lose the bet. A recent conversation with Mr. Roc Yang (CEO of China Data Group, a leading Chinese BPO) forced me to acknowledge for the first time that perhaps Benny could win the bet after all.

Mr. Yang raised several reasons why China might beat India on the BPO arena. Some of these reasons I had heard before: lower employee churn rates, lower effective salary, and better infrastructure. While China may have these advantages today, either India will be able to address them over time (as in the case of better infrastructure) or China will face the same problems as its own BPO industry develops further (as in the case of employee churn).

Some of the competitive factors Mr. Yang raised (such as an ability to provide end-to-end services or more sophisticated operational procedures) are quite possibly valid for his specific company but I can’t imagine that they are true for all Chinese BPOs. Moreover, I can imagine conversations with CEOs of Indian BPOs who would raise the exact same factors as competitive advantages that the Indians enjoy. An analysis of who is right is beyond the scope of this blog. Most probably, only time will tell who is right on this issue.

One point that Mr. Yang highlighted however may turn out to be the secret weapon of the Chinese BPO industry. Contrary to popular perception, the Chinese BPO industry has existed for many years and quite possibly is as old as the Indian BPO industry. The reason that the Chinese have stayed under the radar is that they primarily serve the Chinese market. As Mr. Yang pointed out, because their customers are also Chinese they could never count on labor cost differentials as a critical factor in their business. Thus, out of necessity, they have had to be incredibly cost conscious. He believes that because the Indians have enjoyed a large labor cost differential relative to their customers, they have been much less labor efficient than the Chinese BPOs.

I must admit that many Indian BPOs often have an attitude that labor is cheap so we can always throw a lot of bodies at any problem. This has in many cases led to inefficient use of labor. If Chinese BPOs have truly figured out a way to be profitable in the absence of a labor cost advantage and are now shifting their attention to the US market then Indian BPOs may have cause for concern. An industry that is used to running lean and mean in their own country would have a huge advantage once they gain the additional advantage of the labor cost differential between China and the US. Look out India!

In reality, if the Chinese BPOs can truly bring labor-efficient solutions to the market, that would only spur Indian vendors to respond similarly. Due to the high employee churn rates and salary increases, Indian BPOs have already started to become more labor efficient. The entry of labor-efficient competitors from China would only accelerate the trend. I would expect to see even faster efficiency and accuracy improvements primarily via the adoption of new technologies and consistent processes across customers. This competition from China may just help spur the Indian vendors to the next stage in their evolution.

Bangalore nee Boston Globe: why the privacy red herring may come back to haunt the Boston Globe union

If you haven’t heard about the union objections to the Boston Globe outsourcing 50 positions to India, then you should see the Boston.com or Times of India or the Outsourcing Weblog sites. You can also see the actual ad here (as a pdf).

The union says: “Further, billing and account information will now be shipped overseas to Bangalore, India, putting customers’ most vital information at risk.” As I have written several times before, this is a red herring. Outsourcing these task to India may actually improve information security. Remember, just last year Boston Globe saw one of the most absurd privacy breaches I have ever heard of. If you have forgotten, here is a quick reminder from a Boston.com story.

Credit and bank card numbers of as many as 240,000 subscribers of The Boston Globe and Worcester Telegram & Gazette were inadvertently distributed with bundles of T&G newspapers on Sunday, officials of the newspapers said yesterday.

The confidential information was on the back of paper used in wrapping newspaper bundles for distribution to carriers and retailers. As many as 9,000 bundles of the T&G, wrapped in paper containing subscribers' names and their confidential information, were distributed Sunday to 2,000 retailers and 390 carriers in the Worcester area, said Alfred S. Larkin Jr., spokesman for the Globe.

In addition, routing information for personal checks of 1,100 T&G subscribers also may have been inadvertently released.

The Globe and T&G financial information was inadvertently released when print-outs with the confidential information were recycled for use as so-called "toppers" for newspaper bundles. A topper, placed on top of abundle of newspapers, is inscribed with the quantity of papers in each bundle and the carrier’s route number.

Oh, the irony! Before using privacy as a Fear Uncertainty and Doubt (FUD) attack against outsourcing, the union should have remembered that those who live in glass houses should not throw stones.

Related Posts:

• Reprise: Consumer privacy protection and outsourcing to India
  
• Consumer privacy protection and outsourcing to India
  
• Who would you trust with your credit card number: an Indian college grad, or an American felon?
  
• Nasscom’s new Data Security Watchdog: it has bark, will it have bite?
  
• Really informative article on the Information Security laws in India

Consumer privacy protection and outsourcing to India

I recently came across a Statement on Outsourcing and Privacy to two California Senate committees by an organization called the Privacy Rights Clearinghouse. The statement starts with:

I do not want to infer that companies outside the U.S. are less capable of protecting records containing personal information. On the contrary, news accounts of several such offshore companies describe security practices that far exceed the privacy protection strategies of many U.S. businesses.

However, it then goes on to list several consumer protection concerns with offshore outsourcing. Generally, most people don’t realize that outsourcing contracts are rarely signed directly with an Indian company. Almost every outsourcing contract I have seen is set up with an US or UK domiciled company which is backed up by significant insurance coverage from a major insurer. In most privacy / information security situations, the real recourse is financial compensation via legal action. Because of the structure of these outsourcing relationships, there are sufficient assets that a litigant could go after in US courts even when the delivery happened from India.

However, let me comment on each of the concerns raised by the Privacy Rights Clearinghouse in order. [Please note that I am most comfortable talking about offshore outsourcing to India, but several of my comments are probably generally applicable. Disclaimer: I am not a legal expert and these are just my personal opinion.]

What recourse does an individual have if his/her personal information is handled improperly by an overseas company? Most countries to which data is being transmitted have no data protection laws on the books.

India does have several laws that address data protection and several more are in the works. Moreover, even “Undisclosed information and trade secrets” are protected under WTO-TRIPS (see Understanding the WTO for details) and India has to comply with TRIPS. Finally, the outsourcing industry is a powerful lobby in India and they have been pushing hard for stringent data protection laws to be enacted. In general, over time, a country like India which has a significant portion of its GDP and growth tied to information security is more likely to adopt stringent laws than even the United States.

If a U.S. law or regulation is violated, will the appropriate U.S. regulatory agency, such as the Federal Trade Commission or the Office of the Comptroller of the Currency, send investigators to the offshore company to conduct an investigation? Probably not likely.

If an US agency really needed to, they could probably collaborate with the appropriate Indian agencies and conduct such an investigation. For example, the US Food and Drug Administration (FDA) inspects medicine factories in India. Far more likely, US regulatory agencies could leverage India’s enforcement obligations under WTO-TRIPS, the 1999 US-India mutual extradition treaty and their 2001 Treaty on Mutual Legal Assistance in Criminal Matters to pursue the matter.

If an employee of an overseas company observes improprieties and wants to blow the whistle, who can he or she contact to file a complaint? And will that individual be protected by U.S. whistleblower laws? Again, not likely.

This is an excellent question and we should also consider the broader question of whether US style whistleblower protection is sufficient to promote the transparency we seek.
First, India does have an interim whistleblower protection mechanism in place and the government is under pressure from the Indian Supreme Court to rapidly enact a more extensive whistleblower protection law. [Note: Whistleblower laws are particularly American and they can actually run afoul of European privacy laws. See the Tip-line bind: Follow the law in U.S. or EU? story for an excellent example.]
Second, in general whistleblowers face severe harassment even when they are protected from being fired due to the US whistleblower laws. Data center employees earn so little each month that just protecting their jobs may not be sufficient incentive/protection for them to come forth and provide information against their employers. Anonymous tip lines on the other hand can easily become a medium for harassing people you don’t like and has a flavor of Soviet era anonymous tips that I don’t particularly like. Perhaps Indian outsourcing vendors and US outsourcing customers can set up a whistleblower fund for rewarding outsourcing employees who report problems that are eventually independently confirmed. Even a small financial incentive of a few thousand dollars would probably compensate these workers for lost wages and harassment due to their whistleblowing and would be more effective than US style whistleblower laws.

If an individual becomes a victim of identity theft and is able to trace the illegitimate access to his or her personal information back to an overseas company, can that individual attempt to take legal action against that company for its negligence? Technically perhaps, but realistically probably not. A bigger question is if the victim of identity theft would even be able to trace back to the source of the data breach. Not likely.

I am not sure I quite understand the premise of this question. Because of the focus on outsourcing, I am assuming the statement is referring to a situation when individual A shares private information with US firm B who outsources the processing of this information to Indian outsourcing vendor C. Whether or not firm B outsources the processing of this information, it would be almost impossible for individual A “to trace back to the source of the data breach” as they would violate information security and industrial espionage laws if they tried to do so independently. More likely, they would compel firm B to divulge the source of the data breach as part of a legal action. In any such legal action, they would merely sue firm B and gain compensation from them; why does it matter whether or not firm B outsourced to a vendor C? Remember, the only real remedy for the victim of identity theft is to sue for compensation. You would usually go after the US firm as that has the deeper pockets and was directly responsible for protecting your information.

How would California's law requiring that individuals be notified of security breaches involving sensitive personal information be promulgated and enforced if the illegitimate access to computer files were to occur in an offshore company? (California Civil Code section 1798.82-1798.84)

Outsourcing vendors have to comply with a raft of US laws such as GLB, HIPAA, etc. They are enforced via contractual agreements between the customer and the vendor.

How will U.S. companies be able to prevent overseas firms from subcontracting the work to other companies who then subcontract it to yet others? In a widely reported incident, a subcontractor in Pakistan threatened to expose the personal information contained in the medical records she was transcribing if she were not paid what she was due. (David Lazarus, "A tough lesson on medical privacy: Pakistani transcriber threatens UCSF over back pay," San Francisco Chronicle, October 22, 2003.)

Once again, subcontracting is preventable with proper contract design. Moreover, as discussed earlier, local authorities would prosecute such a person exactly the same way as US authorities.

Why globalization does not mean your job will get outsourced to India

We live in a “flat world” where physical location does not matter and where jobs will migrate to the least expensive locations. An Indian worker may cost 60% less than an equivalent American worker. Does this mean your white collar job will necessarily move to India and that you might as well give up the fight and reconcile yourself to Ross Perot’s “giant sucking sound”? Not necessarily.

Labor costs are not a perfect indicator of overall costs. To make an apples-to-apples comparison between an American worker and an Indian worker we have to consider the total costs of their performing equivalent tasks. The three major additional components of total cost are: productivity, quality, and management overhead. Let’s tackle these in order:

• Productivity: First, some basic math: If one person costs $10 / hr and takes two hours to do a task, while a second person costs $15 / hr and takes just one hour to do the same task, which would you rather employ? If you didn’t sleep through math, you realized that the first person costs $20 per task, which is more than the $15 per task that the second person costs. Thus, you would select the second person even though her hourly rate is higher. So, the question is: who is more productive, an American worker or an Indian worker? It is tough to say. What we can say for certain is that our productivity is under our control and can be improved by orders of magnitude through process innovation. My favorite example of this was described by Dr. Michael Hammer in his “Reengineering Work: Don't Automate, Obliterate,” article in the Harvard Business Review. He described how Mutual Benefit Life, an insurance company, transformed a customer application process from a typical turnaround of 5-25 days and a best effort time of 24 hours to a typical turnaround of 2-5 days and a best effort time of just 4 hours. Mutual achieved this by creating a new position called a case manager and empowering these workers to process entire applications instead of having applications “go through as many as 30 discrete steps, spanning 5 departments and involving 19 people.” “Case managers have total responsibility for an application from the time it is received to the time a policy is issued. Unlike clerks, who performed a fixed task repeatedly under the watchful gaze of a supervisor, case managers work autonomously. No more handoffs of files and responsibility, no more shuffling of customer inquiries.” The productivity gain achieved by this company would be more than sufficient to offset the 60% difference in labor costs between Indian and American workers. Moreover, the job of the case manager is far more complex and “high-touch” than the tasks performed by the original clerks and is far less likely to be outsourced in the future. Dr. Hammer concludes his article with “We must have the boldness to imagine taking 78 days out of an 80-day turnaround time, cutting 75% of overhead, and eliminating 80% of errors.” Such boldness and innovation are far greater assets than 60% labor cost differentials.
  
• Quality: Well, you guessed it, time for some more math. Let’s say processing an insurance claim correctly costs $1. How much do you think correcting an error in an insurance claim costs? Well, once you add up the cost of quality control, the call center costs for fielding customer complaints, and the cost of reissuing a corrected claim, the costs climb quite high. Let’s say the cost is $100. If the error rate is 3%, then this company would be spending three times as much on the downstream cost of errors as on the original claim processing costs. Thus a 1% change in error rates would have the same total cost impact as a 3% difference in labor costs. The specific ratio of the cost of errors to original processing costs varies from case to case; however, the cost of errors is almost always greater than the processing costs. Thus, output quality is almost always more important than labor cost. In other words, if outsourcing increases your error rate even slightly, it can wipe out the benefits of lower labor costs. In one case, an US insurance company outsourced its claims processing to a BPO vendor that delivered 30% lower claims processing costs. Unfortunately, the vendor’s error rate was also slightly higher than the customer’s: just 1.1% instead of the original 1.0% error rate. Such a small 10% difference in error rates seems trivial, but it is sufficient to wipe out the benefits of the 30% cost difference from outsourcing. [For details, see the Case Study at www.totalcostoferrors.com/atcecasestudy]
  
• Management and training overhead: It is not easy to manage a task from across the world. You need proper oversight mechanisms which often require expensive international travel, managers who are trained in cross-cultural interactions, information security safeguards, etc. Other factors such as the high employee churn rate in India and the resultant training costs contribute to management overhead as well. In general, due to relatively high management overhead the overall cost benefits of outsourcing to India are often reduced to just 10 to 20%.

Once we consider the total cost differences between an American worker and an Indian worker, we find that the 60% labor cost differential is much less important than all the other factors that are included in the total cost. Thus, if American workers focus on their productivity and quality while leveraging their inherent management overhead advantages, they can effectively compete against Indian workers notwithstanding the labor cost difference. The unfortunate reality is that instead of focusing on these goals Americans are focusing on protectionism. In the meantime, Indians are focusing on improving these exact same factors. Let’s revisit them again:

• Productivity: If you visit a major Indian Business Process Outsourcing vendor you will be amazed by the way it manages its productivity. In many ways the major Indian firms have replicated the assembly line in a business process environment. While Indian firms aggressively adopt methodologies often invented in America, US firms are beginning to lag behind the Indians in process improvement in the service industry.
  
• Quality: The quality of Indian providers varies widely. I have evaluated vendors who had critical errors in more than 17% of processed documents, and I have evaluated others that demonstrated less than 0.5% errors. What is uniformly true is that most major Indian firms are investing heavily on quality improvement methodologies and software.
  
• Management and training overhead: While employee churn remains a significant problem, Indian firms have come a long way in tackling this problem through improved training systems. They are also beginning to invest in business service operations management software and some of the leading firms have even created home-grown management software. The most obvious change is in the corporate cultures of the larger firms. In 1999, I remember being surprised by the lack of sophistication of many Indian outsourcers. Today when I deal with the larger Indian vendors, it is easy to imagine that the meeting is taking place in New York or London and the vendor’s managers are invariably steeped in western corporate culture.

When the Japanese motorcycle manufacturers first entered the US market, the dominant British manufacturers laughed at them. The larger Japanese motorcycles leaked oil, “looked ridiculous,” and broke down regularly. The smaller Honda Cubs were considered “toys” by serious motorcycle enthusiasts. Their only advantage was that they were cheaper than British motorcycles. While the British laughed, the Japanese improved their motorcycles until they essentially drove the British out of the motorcycle business. It is true that Indian BPO vendors still have many problems with employee churn, security, infrastructure, quality; and today I truly believe Americans could give Indians a serious run for their money based on the overall cost of business processes. However, if Americans remain distracted by protectionism they will lose the chance to improve themselves and compete fairly for their slice of the global business process market.

I have a fierce belief in the inherent abilities of Indians and Americans. Americans today believe that the game is unfairly stacked against them due to the low Indian labor costs and they are essentially refusing to play the game. You can’t win a game that you don’t show up for! Of course Americans can’t beat the Indians on labor costs, but these costs are only a small portion of overall costs. Americans need to rejoin the game and figure out how their inherent strengths in innovation, management / training overhead and possibly quality can counter the core strengths of the Indians in productivity and costs. That would be a fair match worth competing in, and may the one with the lowest overall cost win.

The outsourcing bogeyman is the real threat to the US economy

It seems I managed to confuse some of my readers with my "Why a US ban on offshore outsourcing is the best possible thing for India!" post. I was using sarcasm to make a point, and am not really suggesting that the US ban outsourcing. Any ban on outsourcing would harm both countries overall, but would be especially harmful to the US. Let me make the same point using economic data rather than humor:

Right now the focus is on Business Process Outsourcing (BPO), however, during 1998 to 2002 everyone was convinced that IT outsourcing (ITO) to India would gut the American IT services industry. Let us consider the IT services most directly affected by offshore outsourcing, namely: “computer and data processing services” and “data base and other information services.” According to the “Digital Economy 2003” report published by the U.S. Department of Commerce, US imports of these services rose from $0.3 billion in 1995 to $1.2 billion in 2002 (with a peak of $1.6 billion in 2000). This seems to be clear proof of Ross Perot’s “giant sucking sound” and any number of Lou Dobbs’ tirades. However, in the same time period, US exports of these services rose from $2.4 billion in 1995 to $5.4 billion in 2002 (with a peak of $5.7 billion in 2000). Thus, the U.S. trade surplus in these services expanded from $2.1 billion to $4.2 billion over the same years when the US faced the greatest threat from Indian outsourcing firms due to the Y2K contracts and the Internet boom.

If the US had magically managed to “ban IT offshoring” and other countries had done the same, the US economy would have lost $26.2 billion over these 8 years. How many US jobs do you think that $26.2 billion translates to? I realize data provides cold comfort to people who have lost their jobs due to outsourcing. However, the above analysis highlights how overall global trade creates far more jobs in America than it destroys. If you don’t believe the analysis above, you should at least learn from US history. The following excerpt from the US Department of State website highlights how US protectionism contributed to and exacerbated the Great Depression.

The Smoot-Hawley Tariff Act of June 1930 raised U.S. tariffs to historically high levels. The original intention behind the legislation was to increase the protection afforded domestic farmers against foreign agricultural imports. … But once the tariff schedule revision process got started, it proved impossible to stop. Calls for increased protection flooded in from industrial sector special interest groups and soon a bill meant to provide relief for farmers became a means to raise tariffs in all sectors of the economy. When the dust had settled, Congress had agreed to tariff levels that exceeded the already high rates established by the 1922 Fordney-McCumber Act and represented among the most protectionist tariffs in U.S. history.

The Smoot-Hawley Tariff was more a consequence of the onset of the Great Depression than an initial cause. But while the tariff might not have caused the Depression, it certainly did not make it any better. It provoked a storm of foreign retaliatory measures and came to stand as a symbol of the ‘beggar-thy-neighbor’ policies (policies designed to improve one’s own lot at the expense of that of others) of the 1930s. Such policies contributed to a drastic decline in international trade. For example, U.S. imports from Europe declined from a 1929 high of $1,334 million to just $390 million in 1932, while U.S. exports to Europe fell from $2,341 million in 1929 to $784 million in 1932. Overall, world trade declined by some 66% between 1929 and 1934.

Thus, between 1929 and 1934, US imports were reduced by just $944 million while exports were reduced by $1,557 million and so the US economy lost hundreds of millions of dollars and more importantly tens of thousands of jobs due to US protectionism. Moreover, today due to the high growth rate of countries like India and China, the rest of the world counts for a significantly greater proportion of global economic growth than they did in the 1930s. As such, US protectionism would probably harm the US even more in the current environment because American companies would be locked out of the rapidly growing Asian economies while Asian and European companies would probably benefit from the vacuum created by the absence of American companies.

Daniel W. Drezner in his thought-provoking article titled “The Outsourcing Bogeyman” (Foreign Affairs, May/June 2004) provides two excellent examples on how US protectionism has already caused US job losses.

Consider the example of candy-cane manufacturers: despite the fact that 90 percent of the world's candy canes are consumed in the United States, manufacturers have sent much of their production south of the border in the past five years. The attraction of moving abroad, however, has little to do with low wages and much to do with protectionism. U.S. quotas on sugar imports have, in recent years, caused the domestic price of sugar to become 350 percent higher than world market prices. As candy makers have relocated production to countries where sugar is cheaper, between 7,500 and 10,000 workers in the Midwest have lost their jobs -- victims not of outsourcing but of the kind of protectionism called for by outsourcing's critics.

A similar story can be told of the steel tariffs that the Bush administration foolishly imposed from March 2002 until December 2003 (when a ruling by the World Trade Organization prompted their cancellation). The tariffs were allegedly meant to protect steelworkers. But in the United States, steel users employ roughly 40 times more people than do steel producers. Thus, according to estimates by the Institute for International Economics, between 45,000 and 75,000 jobs were lost because higher steel prices made U.S. steel-using industries less competitive.

Proponents of American protectionism should keep such recent misadventures in mind while pushing for higher tariffs.

US protectionism impacts more than just the economy. The previously quoted US Department of State article goes on to say: “More generally, Smoot-Hawley did nothing to foster trust and cooperation among nations in either the political or economic realm during a perilous era in international relations.” Does this sound eerily applicable in the current international relations context? George Santayana wrote: 'Those who cannot remember the past are condemned to repeat it.' Unfortunately, the cost of repeating this past mistake could be greater than the anti-globalization brigade can even imagine.

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!”