Business Standard, 20 March 2017
Many in India are dismayed at the restrictions upon work visas that are being brought in by the Trump administration. However, the `body shopping' business, which relies heavily on these work visas, is not optimal for India. When this easy choice is taken away, both ends of the business (in the US and in India) will converge on making true offshoring work. This is in India's interests.
The body shopping business may be caricatured as follows. A company in the US replaces local engineers at $10,000 a month using Indian engineers at $5,000 a month. This trade is enabled by `work visas', which are given to Indian companies that specialise in this HR business.
The Trump administration is believed to be working on restrictions to this business. Many in India are dismayed at this possibility. For some software companies, which are heavily in this nature of work, reduced access to these visas is an existential threat. However, when the dust clears, this is likely to work out well for India.
Doing work in India is the higher value added business when compared to body shopping. It takes less capability to hire visa lawyers, conduct interviews, ship bodies to the US, and place them under the direct supervision of the client. It takes more capability to understand what clients require, enter into complex contracts with them, and manage teams in India that deliver the work.
Let's stand in the shoes of the US corporation, which is not excited when it no longer has this easy option. How is this corporation going to respond? American corporations know about Indian pricepoints and are not going to suffer the costs of nativism. The answer will be: The more complex management and contracting structures that are required to do true offshoring, where the work is sent out to India. This can happen in two ways: The US corporation could build operations in India directly, or it could contract with an Indian company.
Some Indian software companies have an excessive dependence on the easy money that comes with body shopping. This business will shrink. Market share will shift in favour of companies that know how to manage teams in India, and deal with the complexities of management and contracting with customers far away.
The normal pattern is that more productive firms export and the most productive firms do outbound FDI. In 2012, a paper by Rudrani Bhattacharya, Ila Patnaik and I uncovered a curious phenomenon with software. We found the opposite pattern: the software companies that did outbound FDI were the less productive ones. The most productive software companies were those that sat in India and exported. (See Export Versus FDI in Services, in The World Economy, January 2012).
What was going on? The best companies were building knowledge on managing teams to deliver complex problems and entering into complex contracts with customers who were far away. The weaker companies were setting up offices in other countries (i.e. outbound FDI) and giving customers on-site staffing services.
We are only at the early stages of this story. Many pieces are in motion. The stock market is marking down the prices of companies that depend more on body shopping. Capital is shifting to the more productive firms. More American companies will do FDI into India, building operations they directly control, which will further diffuse management knowledge into the Indian labour market. Body shopping firms will also recruit the management talent that is required to jump up to the next level.
True offshoring is better, from our point of view, for six reasons:
- It involves greater knowledge and fosters building organisational capabilities in India.
- In the body shopping arrangement, the Indian worker gets paid $5000 a month and the body shopping company gets a fee of $500 a month. Therefore revenues of $500 a month reach India. Let's be pessimistic, and think that with true offshoring, the Indian worker gets $1000 a month and the management overhead is $1000 a month, adding up to $2000 a month being paid into India. This is still a 4x gain for Indian GDP. Jobs for low skill Indians in the US will be replaced by jobs for higher skill Indians in India. Spending in India will go up, and the trickle down economics will accrue to India.
- Body shopping contracts are typically time-and-materials contracts. When productivity gains generate reduced labour requirements, the Indian company experiences reduced revenues. True offshoring can often be done using fixed price contracts. This gives the incentive to the Indian company to fight for productivity gains, which would then yield enhanced profit rates. This is a superior arrangement from an Indian point of view as it creates incentives to improve productivity.
- The US was unusual in having an open work visa system, which created an emphasis upon the US for the body shopping business. When a software company learns how to do management and graduates to true offshoring, its potential market expands from just the US to all countries. We could then sell to countries with restrictive visa systems, such as Japan.
- When there is genuine management capability in India, software offshoring to India is not just about wage price arbitrage. We could also sell software services to a low income country like Sri Lanka where the foot soldiers are equally inexpensive but the management capabilities are weaker.
- There is a human side to this. We in India tend to assume that people working abroad are doing well. There is, however, a remarkable psychic cost for most Indians who struggle to assimilate. There are few things more unpleasant than being an outsider, trying to ape the locals, and staying Indian in exaggerated ways. Being an NRI is not a nice life in many cases. To the extent that body shopping is replaced by true offshoring, and we switch from workers living abroad to workers living in India at a PPP equivalent wage, everyone is better off other than sellers of non-tradeables in the US.
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