Global: India’s Awakening
morganstanley.com
Stephen Roach (New York)
First impressions are superficial almost by definition. But more often than not, they end up pointing you in the right direction. Quite simply, I was blown away by what I saw on my first trip to India. It’s a land of great contrasts, to be sure -- strength in human capital and technology coexisting with backward infrastructure and heart-wrenching poverty. But there is no doubt in my mind that the balance has shifted. After decades of stop and go, the critical mass of a new approach to Indian economic development now appears to have been attained. If I’m right, not only would that have enormous implications for the world’s second most populous nation, but it could have profound implications for the Asian and broader global economy.
I just spent four days in India at the end of a two-week tour in Asia that also included China, Korea, and Japan. I visited with government officials in New Delhi, software companies in Bangalore, and investors, as well as technology, pharmaceutical, and industrial companies in Mumbai. I also met with several rapidly growing Indian subsidiaries of US multinationals. In addition, I took a long and arduous side-trip to Agra, where I was stunned by the sheer majesty of the Taj Mahal. I asked many questions, gave a few speeches, took copious notes, and recorded hundreds of digitized snapshots that have quickly become boring to my family and friends. There’s a fair amount of sensory overload in trying to sort through all the images, conversations, and insights that get filed away in a trip like this. But this visit to India was the missing piece in my Asian education. Up until now, it’s been a China-centric journey -- some 25 trips since 1997. But I have long suspected that there’s far more to Asia’s remarkable story. India convinced me that my instincts were right.
It’s tempting to make the China-India comparison -- trying to figure out which of these two Asian giants has the better approach to economic development. I see no reason to frame this in such black and white terms. In fact, I am inclined to argue that it’s not China or India but, in fact, China and India. Each of these two nations has a distinctly different recipe for economic development -- recipes that are complements rather than substitutes as they fit into the broad mosaic of globalization. To be sure, China has come first in the sequencing, but this breakthrough has served India well. As the rest of the world has finally come to accept the China miracle, that realization has opened the door for acceptance of the India miracle. As one Indian leader put it to me, “It’s the flying-geese pattern of Asian development.”
As China is to manufacturing, India is to services. That’s an over-simplification but it is the key conclusion that I take away from this journey. Manufacturing prowess is typically the yardstick that is used to measure the prosperity of emerging nations. As seen from that standpoint, there’s no comparison. China has plowed its huge reservoir of domestic saving -- about 40% of GDP -- into some of the best infrastructure you will see anywhere in the world. And it has been brilliant in attracting massive inflows of foreign direct investment as the means to acquire technology, managerial expertise, and factories on a scale and scope that is hard to believe. China has, in fact, leapt to the fore as the largest recipient of FDI in the world -- some US$53 billion per year in 2002-03.
India suffers in comparison basically from having none of the above. That’s an exaggeration but not all that wide of the mark. India has a 24% national saving rate, a little more than half that of China. As a result, it has far less in the way of internally-generated funds available to plow back into infrastructure. And it doesn’t take much traveling around in India to experience first-hand the serious deficiencies of its infrastructure. The India Infrastructure Report 2004, put out by the 3iNetwork of India’s best and brightest engaged in this field, says it all, “…even relative to our income, our failure in water, roads, sanitation, schooling, and electricity is woeful.” Nor can India hold a candle to China on FDI. China’s inflows in 2003 were more than ten times the US$4 billion that went into India.
But that’s not the lens through which India should be viewed, in my opinion. India’s strength is elsewhere -- namely, in an extraordinary stock of human capital. And it has deployed that strength into the creation of world class IT-enabled service companies such as Infosys and Wipro and the service subsidiaries of large conglomerates such as Reliance and Tata. I spent time with each of these companies and was staggered by what they had accomplished in the relatively short time span of the past 10-20 years. The push into IT-enabled services sidesteps what I believe are India’s greatest impediments on the road to development -- its infrastructure and FDI deficiencies. Self-sufficient in electrical power -- all big companies have back-up generating capacity -- the only infrastructure requirement in services is telecom. And, here, the Indian government has gotten out the way -- focusing on telecom deregulation and facilitating connectivity both in domestic markets and to overseas destinations.
The results speak for themselves: By year-end 2003, growth in Indian services was nearing a 10% annual rate, well in excess of the 6% growth in industrial production. For the first time ever, services exceeded 50% of Indian GDP in FY03 -- at 50.5% this portion is up about ten percentage points from the share in 1991 but still well below the 65% average shares in more developed economies. While the combined sum of IT services and IT-enabled services (ITES) is growing very rapidly, it currently accounts for only 2.0% of Indian GDP as of March 2004; the export portion of ITES is estimated at US$3.6 billion in 2003-04 -- more than double the level of 2001-02, according to NASSCOM, India’s IT trade association. The US is a destination for about two-thirds of such exports. One of India’s leading IT companies has a row of flagpoles lining the entrance to its state-of-the art headquarters complex. Each day, national flags are raised for foreign visitors. They tell me the American flag is flying nearly every day.
India’s software and IT-enabled services industry currently employs about 785,000 workers -- this is up by nearly 60% from the headcount of 500,000 two years ago and projected to increase by around 50% by year-end 2005. Nor are there any serious worries about hiring constraints. Nearly 290,000 engineers alone graduated from India’s high-quality universities in 2002. As one IT executive put it to me, “Hiring from campus is a cinch. For new grads, our industry is a godsend.” Despite this rapid growth, the level of activity in this dynamic new industry is still low and hardly justifies the outcries of America’s anti-offshoring fanatics. But as I argued recently, the trend is emblematic of powerful change at the margin -- suggestive of new and lasting competitive pressures that are likely to bear down on America’s legions of long-sheltered knowledge workers for the foreseeable future (see my March 30 dispatch, “Offshoring -- Myth and Reality”). It’s called globalization, and that’s exactly the way it’s supposed to work.
It is important to stress that contrary to widespread impressions there is far more to India’s success in services than an attractive cost arbitrage in low-valued processing tasks. Yes, the cost saving is enormous -- like-quality Indian talent goes for about 15% to 20% of the Western norm. But the strength of India’s IT-enabled services model is not about the inroads it has made in attracting easily commoditized data processing and call-center operations. The successful IT-enabled service companies have been quick to move up the value chain into a wide range of BPO (Business Process Outsourcing) activities including purchasing and order functionality, procurement, accounting, insurance management, e-based corporate learning management, human resource and benefits management, and a vast array of internal corporate control functions. More recently, India’s BPO efforts have moved into medical, actuarial and legal functions. And then there’s India’s natural strength in a broad array of IT applications -- from software programming and multi-media platforms to systems support and network management.
The list goes on and on. But for Indian IT companies, the real breakthroughs come from the development of customized integrated systems solutions. The BPO business is basically the “Trojan Horse” -- driven initially by the cost arbitrage that makes outsourcing extremely attractive as a means to enhance corporate efficiency in high-cost countries. But India’s IT-enabled service companies have been quick to take this opportunity to the next level -- going beyond the functional “silo approach” that has long plagued corporate structures and exploiting the synergies that can be realized through collaborative solutions that span previously segmented functions. And they attack these integrated systems problems with seamless global networks that pass the management and control functions around the world every 24 hours. This revolutionizes the high-cost “cluster model” of the global services company made famous by Harvard’s Michael Porter (see The Competitive Advantage of Nations, Free Press, 1998). Porter argued that since services had to be delivered on site, in person, well-supported subsidiaries of global service firms had to be located in close proximity to major customer bases. India’s IT-enabled services model turns this concept inside out. These are real companies, with powerful new strategies and execution models that go well beyond the arbitrage play.
As logical as India’s service-based development model seems to me, I was surprised to find some pushback from the Indian leadership. The country is enormously proud of its accomplishments over the past 12 years in IT-enabled services -- and justifiably so. But it still believes that manufacturing ultimately holds the key to prosperity. Repeatedly, I heard the argument that manufacturing is critical to resolving India’s long-term unemployment problems. I find this response puzzling. Over the past 50 years, technological change has spurred capital-labor substitution and turned manufacturing into an increasingly labor-saving activity. Services, by contrast, are far more labor intensive, especially in the knowledge-based production activities of the Information Age. For a huge country like India, a services-driven development model seems tailor made both to its greatest strengths (human capital) and its greatest needs (employment and coping with poverty). And the new IT-enabled tradability of services is the icing on the cake. Many moons ago in grad school, I was very impressed by the elegance of India’s manufacturing-based development models. For lots of reasons they never really delivered. India’s new services-based approach is an exciting alternative, but it runs very much against the grain of these powerful legacy effects. Sometimes, old dreams just don’t fade.
What impressed me the most about India is a new sense of focus and determination. Plagued by decades of false starts and government missteps, this Asian giant has now, in the words of one of India’s leading corporate executives, finally absorbed the “fixed costs of democracy.” Reforms began in earnest in the early 1990s and momentum has built steadily in the years since. India still suffers by comparison with China. But unlike China, India has a well developed banking system, vibrant capital markets, and a new generation of indigenous world-class companies. China has an outward-looking development model with the hope that the benefits will spread inward into home markets. India has much more of a home-grown development model that is now gaining global reach. Both approaches have their virtues and shortcomings. And yet the most fascinating thing is that they both may work. I have long been a big fan of China’s remarkable accomplishments. India’s awakening is equally impressive. |
