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Email this citationCIAO DATE: 7/99
India’s Economic Prospects: The Promise of Services
Swaminathan S. Anklesaria Aiyar
CASI Occasional Paper Number 9
April 1999
Center for Advanced Study of India
University of Pennsylvania
Overview
India is about to enter the new century after nine years of half-baked reform. This has produced half-baked success. In the Eighth Plan period, 1992-97, GDP growth averaged a record 6.9 per cent annually, well above the 5.8 per cent averaged in the 1980s. Subsequently, growth dipped to 5.0 per cent in 1997-98 and an estimated 5.8 per cent in 1998-99, leading businessmen to groan about recession. But in the context of the Asian financial and economic crisis, it is one of the highest growth rates anywhere in the world. And the very fact that growth of 5 to 5.8 per cent is regarded as recessionary is sign of progress. Provided the creeping liberalization of recent years continues—and that looks probable on the basis of both economic fundamentals and political realities—India is well positioned to maintain an average growth rate of over 6 per cent.
There is debate on whether the improvement in the 1990s is substantial and sustainable. The economy remains riddled with many weaknesses, strong interest groups have slowed the pace of reform, and the world economy (on which India has become more dependent) looks far more fragile than before.
Yet I remain an optimist. India has failed to do several things necessary to become a great manufacturer-exporter like other miracle Asian economies. And socio-political pressures suggest that progress in this area will be slow. However, India is rapidly becoming a service economy, and service exports are booming. Manufacturing efficiency depends on traditional infrastructure ( roads, railways, ports, power) which is hamstrung by bottlenecks, poor policy, and militant trade unions. But the new service exports are transmitted by satellite and cable, and suffer few of the policy or infrastructure problems that plague manufacturing.
India has a major comparative advantage in services, which it lacks in manufacturing. The whole world economy is moving from manufacturing to services. That makes India’s prospects in the 21st century look quite favorable. The importance of the structural shift has not been appreciated widely enough. In this lecture I wish to highlight the promise that the shift to a service economy holds for India.
The political economy of economic reform
For four decades after gaining independence in 1947, India had a national consensus on socialism. Remarkably, this has been replaced in the 1990s by a national consensus on economic liberalization. The process was started by the Congress Party in 1991, amidst angry protests from other parties. Many expected reform policies to be reversed when Congress lost the 1996 election. The new United Front government comprised parties like the Janata Dal and two Communist parties that had stridently criticized the reforms in 1991. Yet the new government continued, slowly, on the path of reform.
The Bharatiya Janata Party, the third major political player, lambasted both Congress and the United Front. Yet on coming to power in 1998, the BJP diluted its long-cherished policy of swadeshi (Indians first) and continued moving (though slowly) towards an open economy.
Why has the national consensus changed? First and foremost, four decades of socialism have bankrupted both central and state governments, which are now bowing to the compulsions of an empty treasury. Second, the collapse of the Soviet Union has shown that the solution is not more socialism. Third, the very fact that reform has produced not a lost decade (as predicted by critics) but record growth has kept India on the reform path.
However, the fact that reform has been driven by bankruptcy rather than ideology has consequences. Politicians have moved towards the market more in confused sorrow than ideological triumph. Many try to retain their bad old habits to the extent feasible.
For four decades, politicians used the holy name of socialism to cater to their private agenda. They used ever-rising public investment to build patronage networks and obtain kickbacks. And since this made them unpopular, they favored ever-rising subsidies to mollify irate voters. This made them doubly anxious to accelerate public spending, which was financed increasingly by borrowing. Since the borrowings were poorly used, the rising debt burden led eventually led to a fiscal crisis, which spilled over into a balance of payments crisis.
When fiscal bankruptcy struck in the 1990s, politicians at both central and state levels found they no longer had enough money to finance high levels of both public investment and subsidies. To their dismay, they found they had to choose one or the other. They opted, across the entire political spectrum, to retain subsidies (which, broadly defined, remain at the pre-reform level of 15 per cent GDP).
Having opted to retain subsidies, central and state governments no longer had enough money for investing in the commanding heights of the economy—mainly infrastructure and heavy industry. So it became imperative, even for communist and socialist politicians, to try and attract foreign and private investment to fill the space vacated by the government. This explains the evolution of the new consensus on liberalization.
However, it is a consensus on half-baked liberalization. All parties now seem to say the following:
- We must continue wooing private and foreign investment, and so make the economy more market-friendly.
- We must continue to subsidize everything in sight, and if possible invent new subsidies to woo voters.
- We must not sack any workers (the surplus in the public sector alone is estimated at one million) or close any sick industries.
- Since liberalization has removed many old sources of kickbacks, we must find new ones (like privatization).
This half-baked reform formula falls well short of what is required to make India the next Asian tiger. Yet it has yielded some positive results.
Optimists point out that the Eighth Plan period (1992-97) produced record GDP growth of 6.9 per cent annually. Pessimists dismiss this as statistical obfuscation. Growth in 1990-91 was 1.1 per cent, in 1997-98 was 5.0 per cent, and in 1998-99 is estimated at 5.6 per cent. The average from 1990-91 to 1998-99 works out to 5.8 per cent, not significantly higher than the 5.6 per cent average recorded in the 1980s.
I believe the truth lies in between the optimistic and pessimistic claims. Growth slumped in 1991 when India went bust not because of the reforms but because pre-reform policies led to bankruptcy. So logically the slow growth of 1991-92 should be clubbed with the pre-reform era in terms of outcomes. If we look at the average performance from 1992-93 onwards, GDP growth has exceeded 6 per cent annually, and that I suspect is the best measure we have of sustainable performance right now.
Sustainable is a key word. Growth certainly accelerated in the 1980s, but it was unsustainable growth based on unsustainable borrowing. Foreign debt quadrupled from $20 billion to $80 billion between 1980 and 1990. It has increased by less than a fifth since then, to $95 billion. The fiscal deficit, which touched 8.3 per cent in 1990-91 came down to around 6.5 per cent in 1998-99, still high but not a crisis level. Foreign exchange reserves were down to almost zero at the end of the 1990s, whereas they are a comfortable $30 billion or so as we approach the new century. The current account deficit, which was around 2.5 per cent of GDP in the late 1980s and touched 3 per cent in 1990-91, is now down to 1.4 per cent of GDP.
All these are important gains of the 1990s. So India is definitely better off, regardless of the statistical arguments on whether GDP growth has really accelerated. More pertinent, companies now bemoan a growth rate of 5 to 5.6 per cent as a recession. In the 1980s, such rates were hailed with joy as record growth rates. Whether or not India has had an economic revolution, it has certainly had a revolution in expectations.
Misgovernance is a major problem: criminals do not go to jail, they become members of Parliament instead. Major administrative and police-judicial reforms are needed to check this, yet no party is keen on taking the initiative since all have criminals in their ranks. Without good governance, economic reforms will not fulfil their potential. Infrastructure remains a major problem, and will be a bottleneck in coming years. Foreign investors are willing to pour billions into Indian infrastructure, yet politicians have not yet devised hassle-free procedures for the money to flow in, though there are signs of improvement in telecom policy. Politicians are reluctant to let go of controls, or create transparent systems that remove all possibilities of kickbacks and patronage networks. The labor market remains unreformed, and so does the public sector. The liquidation of companies still takes ages (three cases in the Calcutta high court have been pending for over fifty years). The Urban Land Ceiling Act has been repealed, a positive measure, but not a single state government has yet taken advantage of this.
In sum, the consensus on keeping reform half-baked continues. Hence, sad to say, there is no chance at all that India will soon become the next Asian tiger.
The BJP’s performance
During the 1998 election campaign the BJP as well as its opponents claimed that, once in power, the BJP would indulge in swadeshi radicalism. Both have proved to be mistaken: half-baked reform has continued.
The swadeshi instinct of old BJP hands runs deep. In election after election, the party’s manifesto had pledged to curb foreign investment in consumer goods. While in opposition the party had moaned about cultural imperialism, its foot-soldiers had attacked outlets of Kentucky Fried Chicken, and it had lambasted the preceding government for allowing Pepsi to market bhujiya (an Indian food snack).
I personally did not expect great swadeshi radicalism from the BJP in Delhi, largely because it had refrained from Neanderthal swadeshi policies in state governments where it had come to power earlier. It had bitterly opposed the Dabhol power project of Enron when in opposition in the state of Maharashtra, on the grounds of corruption and inflated cost. On winning the next election in the state, it cancelled the project. Yet soon afterwards the BJP renegotiated the Dabhol project with Enron, tripling the size while cutting the final power tariff. This volte face did more to reassure liberals and foreigners investors about the true character of the party than any number of verbal assurances. It also suggested that a BJP government in Delhi would be tamer than suggested by its swadeshi rhetoric.
Still, I expected it to curb the expansion of MNCs in some consumer goods: in potato chips surely! I did not expect the BJP to cancel any MNC investments in foods and beverages, notwithstanding the RSS claim that junk food was invading and jeopardizing Indian culture. But I did expect some curbs, however cosmetic, on the future expansion of foreign pizza parlors, hamburgers or fizzy drinks. This would have mollified the party’s foot-soldiers without seriously affecting the foreign investment climate.
In fact the BJP has not cracked down on (or even cracked its whip at) a single foreign company, in consumer goods or any other sector. On the contrary, it has allowed 100 per cent foreign equity in sectors like white goods. While in opposition, the BJP said ‘computers chips yes, potato chips no.’ In office, it has said yes to both: Kentucky Fried Chicken and McDonalds continue to churn out rising heaps of potato chips.
The party manifesto said it would not encourage investment in low-priority industries. But the Industry minister, Sikander Bakht, has refused to delineate any sectors as of low priority, and encouraged foreign investment in all, even tobacco and liquor.
It seemed initially that the swadeshi lobby would triumph in insurance. Murali Manohar Joshi, ex-president of the party and an RSS hardliner, scuttled early moves to allow minority foreign equity in insurance. But eventually the liberals in the party had their way. The government has decided to allow 26 per cent foreign equity.
This represents a major turnaround. When the United Front government proposed to allow private investment in insurance in 1997, it said foreign investors would be limited to areas like medical and crop insurance. The BJP initially said it would support this measure but later reneged, and the legislation could not be passed. Today, the BJP’s own bill is a major advance since it does not limit foreign insurance companies to any sector like medical insurance.
Finance Minister Yeshwant Sinha’s first budget in 1998 was supposed to give formal shape to swadeshi protectionism. He introduced a wide-ranging import tariff of 8 per cent, which along with surcharges became in effect 11 to 12 per cent. Sinha expected kudos from swadeshi businessmen. Instead many complained that the duties had greatly raised their input costs. Protests from his own swadeshi brethren obliged Sinha to halve the levy.
This demonstrated to the BJP what has long been obvious to others: that swadeshi is a fuzzy concept in practice. The ideology of strengthening all swadeshi businessmen assumes they all have common interests vis-à-vis foreigners. This is simply untrue. For example, steel producers welcome additional import duties on imports, but steel-using industries will protest bitterly. All machinery and intermediate goods constitute inputs for some industries while being the output of some other industries. Any move that benefits those for whom it is an output will hurt others for whom it is an input.
Consumer goods are the exception: they are not inputs into any other industry. So protection of consumer goods will not pit businessman against businessman. But protection to swadeshi producers of consumer goods will hurt swadeshi consumers. So, no matter how catchy a slogan it seemed earlier, swadeshi in practice has proved to be a very fuzzy concept.
The same fuzziness has changed political attitudes in relation to trying to ensuring Indian control of joint venture companies. The BJP does not like foreign partners buying out Indians, or reducing them to a minority. The Confederation of Indian Industry also protested against this in the early 1990s. Yet in recent years, one Indian businessman after another has found it exceedingly profitable to sell out to foreigners at prices he could not remotely hope to get if buy-outs were restricted to fellow Indians. Analjit Singh is a good example of this: he made over Rs 500 crore by selling his stake in Max Hutchison to his Hong Kong-based partner. Tata Steel has sold its cement operations to Lafarge for Rs 550 crore. The Ghais and Jaiswals sold their ice-cream brands at a good premium to Hindustan Lever (which is losing money in this particular line). The Indian promoters of NOCIL and Bausch and Lomb simply did not have the funds necessary to survive, and were happy to sell out or hand over majority control to foreigners rather than go bust. SRF Finance sold out to GE Capital. The list goes on and on.
Hostile takeovers by foreigners would certainly have been resisted by the BJP or any other party. What the BJP had not anticipated was the rush for friendly takeovers, with Indian businessmen welcoming foreign buyers. The climate for friendly foreign takeovers has changed so much that even the public sector Indian Petro-Chemicals Ltd (IPCL), which is a 50-50 partner with General Electric in a joint venture called GE Plastics, has been cleared by the government to reduce its stake to a minority. GE will now hold 60 per cent of the equity. IPCL will later divest its minority stake. This has attracted no controversy whatsoever, a sign of the changing times.
Yeshwant Sinha’s 1998 budget beat the swadeshi drum, even though in practice there was no follow-through. However, his second budget in 1999 had no swadeshi slant. If anything, it was a quiet affirmation of the government’s intent to continue with the outward-looking policies initiated in 1991. This more liberal line was already encapsulated in the party’s decision to take measures had it had strongly opposed while in opposition—amend the Patents Act in line with WTO rules, and allow foreign investment in insurance.
Sinha’s first budget sent the stock market plunging, but that ultimately turned out to be a false alarm: India did not retreat into a swadeshi cocoon. His second budget cut the top import duty rate from 45 per cent to 40 per cent; promised to expand the list of industries where foreign investment would be allowed automatically without specific clearance from the Foreign Investment Promotion Board (FIPB); promised FIPB clearances within 30 days, and announced the creation of a new outfit to help foreign investors get speedy clearance from state governments as well; allowed foreign pharmaceutical companies (once a much despised species) automatic permission for up to 74 per cent equity in new investments; and encouraged computer software and other service industries by making legal and tax provisions for sweat equity. His second budget came as such a welcome surprise to foreign portfolio investors (whose expectations were very low) that they sent the stock market soaring.
Overall, the outcome of one year of BJP has been favorable than most people expected. One reason is that Prime Minister Vajpayee is by instinct more liberal than the RSS, and has placed liberals in charge of most economic Ministries. A second is the realization, after the first budget proved a flop, that swadeshi is a fuzzy notion that should not become an excuse for protectionism. A third is India’s nuclear test in 1998, which established that the BJP liberals running the government were not running dogs of the west, and that their outward-looking inclinations did not constitute weak-kneed surrender. Liberal economic policies were also seen as a help (though not as an essential ingredient) in making up with the US and getting economic sanctions lifted.
However, we must guard against attempts to paint the BJP as a true liberalizer. In fact it has a powerful labor wing that opposes reform of stifling labor laws, and resists privatization. The party remains committed to the policy of keeping hundreds of items reserved for production by small scale industries. It remains committed to widespread subsidies and hand-outs. In short, it remains a half-baked liberalizer.
In one respect, it could usher in a liberal regime. Vajpayee has understood the huge potential of communications technology to upgrade productivity and create jobs and exports. In the past, the government had different Ministries with different policies for telephones, cell phones, TV, internet, cable TV, direct-to-home, and computers. Vajpayee now swears by convergence—the technological revolution that enables any of these many channels—cell-phones, telephones, the internet, cable TV—to deliver all conceivable voice, data, information and entertainment services. This will not be to the liking of traditional Congress politicians, who liked each Ministry to be a separate empire with separate rules and kickbacks. But the world is moving towards convergence, and the BJP has seen the need to move there. So it has thrown out the old communications policy and gone for a modern one that reduces government monopolies and provides far more scope for private operators. Internet services have been delicensed totally. Duties on IT equipment have been slashed. Whether future governments will stick to the path needed to take maximum advantage of convergence is unclear. But the Vajpayee government has made a decent start.
This still will not solve the myriad problems that affect Indian manufacturing. But it will clear most of the hurdles that affect India’s ability to become a world-class provider of services.
Why India will not become a great manufacturer-exporter
When economic reforms began in 1991, optimists hoped India would soon transform itself to the next Asian tiger. The original tigers were Singapore, Hong Kong, Korea and Taiwan. Then came the tiger cubs, Thailand, Malaysia and Indonesia. And finally came the spectacular performance of Deng’s China. While they followed differing strategies, they had one thing in common: they created conditions favorable for export-oriented manufacturing. This resulted in a new international division of labor, with low-tech factories shifting from higher-wage to lower-wage countries. This increased employment, incomes and prosperity.
Now, creating conditions favorable for export-oriented manufacturing is not easy. Low wages alone are irrelevant: global industries do not shift to Sub-Saharan Africa or Nepal where wages are the lowest. What matters ultimately is productivity. If a poor country has one-tenth Japan’s wages but one-fifth of Japan’s productivity, then Japanese factories will have an incentive to migrate. But if a poor country has one-tenth the wages but one-twentieth the labor productivity of Japan, obviously no Japanese industries will shift.
Labor productivity is determined by several factors. High educational standards and skills help. Top-quality infrastructure cuts the cost of production and movement, facilitates rapid and reliable delivery, and so increases labor productivity. Strong financial markets lower the cost of capital and transactions, and so increase productivity. Flexible and well-enforced laws covering labor, land, and capital (including bankruptcy) aid the rapid redeployment of these factors of production whenever needed, and so increase productivity. Substantial deregulation helps harness entrepreneurial energy. Rapid and fair procedures where regulations are still needed, judicial mechanisms to resolve disputes fairly and quickly, an alert and responsive bureaucracy and polity, a strong civil society with democratic rights, low levels of corruption, all are aids to productivity.
No developing country can claim to have all these attributes. But having a majority of them is enough to create economic miracles, as one Asian country after another has proved.
India, alas, dos not a have a majority of these attributes. Literacy is below 60 per cent. Infrastructure is in a terrible mess. Corruption and bureaucratic sloth are widespread. The financial sector has serious weaknesses. Laws governing factors of the production (land, labor and capital) are rigid. A legal system exists and in some respects works well (as Enron will testify), but legal enforcement is poor because of incompetent police and enormous legal delays. Politicians have neither the guts nor inclination to take on powerful sectional interests like trade unions and farmers. So transactions costs are high, infrastructure is costly and unreliable, and here can be no speedy redeployment of land, labor and capital to meet changing conditions.
This explains why, after eight years of reform, few multinational companies see much promise in shifting factories from other countries to India. India can indeed occupy a few small labor-intensive niches. Sundaram Fasteners, for instance, has become a successful exporter of radiator caps for the global operations of General Motors. But this is a tiny operation. In general, multinationals do not regard India as a cost-effective production center for the global market, and are interested mainly in its domestic, protected market. Hewlett Packard considered using India as an export base but ultimately decided that the infrastructure was neither rapid nor reliable enough.
India’s merchandise exports have indeed grown in the last 15 years. From a low of 4.5 per cent of GDP in the mid-1980s, they now amount to roughly 10 per cent of GDP. However, the composition of merchandise exports has changed surprisingly little. The Economic Survey 1998-99 shows that between 1980-81 and 1997-98, the share of agricultural exports moved from 18.7 per cent to 18.8 per cent, of textiles and garments from 23.7 per cent to 20.7 per cent, of gems and jewelry from 15.1 per cent to 15.1 per cent (no change). Exports of electronic goods are new items that have taken some market share from chemicals and machinery. The remarkably limited compositional change suggests that much of the increase in exports since 1980 has come more from a realistic exchange rate than strident improvements in manufacturing productivity.
Half-baked reform has released entrepreneurial energy and helped accelerate growth. But manufacturing remains plagued by a series of problems, which politicians are reluctant to correct since this would antagonize strong sectional interests. India’s polity is now so fragmented that coalition governments seem likely for most if not all of the foreseeable future. Such fragile coalitions are not well suited to take on strong sectional interests. This is why reform proceeds so slowly, and why India’s manufacturing productivity is not rising fast enough.
Yet there remains cause for hope. India’s economy, as well as the world’s economy, is shifting steadily from industry to services. Half-baked liberalization does not hamper the growth of services, which include many new areas not clogged by vested interests. India appears to have a much greater comparative advantage in services than in manufacturing. That improves its prospects in the coming century.
The shift to services
For decades, industrialization was seen in India as the driving force of modernization and prosperity. The service economy was seen as a mere adjunct to manufacturing, not as a driving force in its own right.
This was a consequence of the mind-set induced by Soviet-style planning, although India never went as badly wrong on this as Moscow did. The Soviet Union measured Gross Material Product rather than Gross Domestic Product, deliberately leaving out services. Other communist countries measuring Gross Material Product also dismissed services as immaterial (literally). Even today, the data-gathering systems of China and ex-communist nations are simply not geared to measuring services accurately. For this reason, their official estimates of the share of services tend to be low and of the share of industry tends to be high.
Neither Jawaharlal Nehru nor Joseph Stalin dreamed that service economies like Hong Kong and Singapore could become richer than their former colonial master, Britain, the country that spearheaded the industrial revolution. Yet today the per capita income of Hong Kong stands at $25,200 and of Singapore at $32,810 against Britain’s $20,870 (WDI 1999).
Initially, Hong and Kong and Singapore specialized in garment sweat-shops and other labor-intensive manufacturing. This helped take them to middle-income levels. But they graduated to high-income status only when they switched to services. The share of services in GDP is no less than 84 per cent in Hong Kong, and 65 per cent in Singapore. The share in the USA is 71 per cent, and its new focus on knowledge-intensive services has made it an economic powerhouse in the 1990s.
India too is becoming a service economy. The share of services in its GDP had been estimated earlier at 45 per cent in 1995, but recently the statistics have been overhauled to take into account services that were missed earlier for want of monitoring. The new official estimate is almost 47 per cent of GDP, against 29 per cent for industry and 24 per cent for agriculture. India has become a service economy without even realizing it or striving for it.
Yet India remains a laggard in services, by not only global standards but even South Asian standards (see Table 1). As against India’s services share of 47 per cent in GDP, Pakistan’s share is 50 per cent, Bangladesh’s 49 per cent, and Sri Lanka’s 52 per cent. India’s ratio is actually lower than that of sub-Saharan Africa (48 per cent) or Latin America (60 per cent).
In high-income countries, the share of services in GDP touched 59 per cent way back in 1980 and rose to 63 per cent by 1997. In this period, their share of industry in GDP declined from 37 per cent to 31 per cent. Today, services account for twice as high a share as industry in high-income countries. That indicates the direction in which India will also have to go in the next century.
| Table 1: The global shift towards services | |||||
| Services / GDP (%) | Sectoral shares in GDP (%) 1997 | ||||
| 1980 | 1997 | Agriculture | Industry | Services | |
| India | 36 | 45* | 25 | 30 | 45* |
| Pakistan | 46 | 50 | 25 | 25 | 50 |
| Bangladesh | 42 | 49 | 24 | 27 |
49 |
| Sri Lanka | 43 | 52 | 22 | 26 | 52 |
| Low income nations | 39 | 43 | 28 | 28 | 43 |
| Middle income | 41 | 52 | 11 | 37 | 52 |
| High income nations | 59 | 63 | 2 | 31 | 63 |
| Sub-Saharan Africa | 43 | 48 | 18 | 34 | 48 |
| Latin America | 50 | 60 | 8 | 32 | 60 |
| East Asia-Pacific | 29 | 37 | 18 | 45 | 37 |
| Middle East - N. Africa | 37 | 48 | 14 | 38 | 48 |
| South Asia | 38 | 46 | 25 | 29 | 46 |
| China | 21 | 37 | 19 | 49 | 32 |
| Indonesia | 34 | 41 | 16 | 43 | 41 |
| Thailand | 40 | 41 | 12 | 47 | 41 |
| Malaysia | 48 | 49 | 11 | 40 | 49 |
| *revised by the CSO to 46.7 per cent Source; World Development Indicators 1999 |
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However, there is a sense in which a high share of services may reflect industrial failure. The miracle economies of East and South East Asia had a very high share of industry in GDP in their peak growth periods, higher in some cases than the share of services (Table 1). The services share of China is depressed by statistical undercounting, but even in Indonesia and Thailand in 1997, the share of industry (43 per cent and 47 per cent respectively) exceeded that of services (41 per cent in both cases). In India the share of industry is around 29 per cent (the table shows 30 per cent, but the data have been revised since). This reflects to some extent India’s failure to become a great manufacture-exporter, like the miracle economies. But there is a silver lining: India can hope to leapfrog over some of its Asian neighbors in services.
The Asian tigers harnessed cheap, skilled labor in manufacturing relatively low-tech goods for global consumption. India hoped to take the same route, but has made little progress. The problem is not just its poor policies: technological change has greatly reduced the potential of comparative advantage based on low wages.
Rapidly increasing mechanization of production means that in most lines of production, the labor content has dropped to below 10 per cent. Only a few manufacturing areas like garments and gem polishing remain truly labor-intensive. The automobile and steel industries were once seen as industries that created lots of jobs. But at Maruti Udyog, India’s largest car company, the labor content of cars is just 2.5 per cent. In the new steel plants of Essar and Ispat India, wages and salaries amount to only 1.3 per cent of sales.
By contrast, the labor content in services can approach 100 per cent. So comparative advantage flowing from cheap skills has far greater scope in services than in manufacturing. Traditionally, this advantage was given little attention because of the difficulty of selling services across national boundaries. But modern technology and communications have revolutionized trade in services.
No longer are services regarded as non-tradable and restricted to the domestic market. A recent article by Dr Kalyan Raipuria ( Economic and Political Weekly, December 27th 1997) shows that world exports of services have been rising faster than world exports of goods (10 per cent annually for services in 1985-95 against 8 per cent annually for goods). Global service exports in 1997 totaled no less than $1,372 billion. This was almost a quarter of global merchandise exports of $5,372 billion (WDI 1999).
India’s service exports in 1997 were $9.3 billion against its merchandise exports of $32.2 billion. Data for 1998 are not yet available, but given the strident rise of software exports and decline in merchandise exports, I expect that India’s service exports will turn out to be around one-third of merchandise exports, much higher than he global average of one-quarter. The biggest and fastest-growing category is “communications, computer software, information and other”, accounting for 43 per cent of India’s service exports in 1997 (WDI 1999).
The liberalization of trade in services has become an important part of the agenda of the World Trade Organization. Its agreement on financial services in December 1997 covers 95 per cent of the world market in services, which adds up to $18,000 billion in securities business, $38,000 billion in banking, and $2,500 billion in insurance. India can hope for only a tiny slice of these. However, the WTO emphasis on financial services tends to obscure India’s comparative advantage in other service areas.
The most well known is, of course, computer software, exports of which have been growing at an amazing rate of 40 to 50 per cent per year in the 1990s. A few years ago, Indian software engineers mostly had to physically move to the USA to do their work (this was called body-shopping). But now the vast majority of work is done in India itself: jobs have shifted from the USA to India. The National Association of Software and Services Companies estimates that software exports grew from $734 million in 1995-96 to $2,625 million in 1998-99, and will grow further to $4 billion in the current fiscal year (1999-2000). Yet this is a drop in the global ocean, since global software output is estimated at $400 billion–500 billion (FC Kohli, Vice-Chairman, Tata Consultancy Services, Dataquest, March 15th 1998). So the scope for future growth remains tremendous. If software exports can keep growing at 50 per cent per year—a big if—then by 2004-2005 they will total a whopping $30 billion per year, almost as much as the country’s entire annual merchandise exports today.
Even at that level, they will constitute no more than one per cent of global software production, so from that viewpoint the target is not excessively ambitious. The key issues are whether India can move up the software ladder from the low-end work to complete solutions, where the big money lies. A big problem is that computerization has progressed very slowly within India, so local software companies have not been able to develop modern skills fast enough. Domestic software business is only one-third of the total, and it is not easy to develop world-class expertise in fields where there is no work experience domestically. However, the Indian government is now keen to push into the information age, the use of the internet is spreading rapidly (from a tiny base), import duties on information technology items have been slashed, and so computerization is gathering pace.
In recent years Indian companies have done a substantial amount of work in helping global companies overcome the YK 2 problem. Pessimists predict a marked deceleration in business once the YK2 problem is over. Optimists point out that Indian companies are already moving into software for the conversion of European currencies into the Euro. And in general Indian software companies have made such a name for themselves globally that business should come readily. Indians have been so successful in Silicon Valley, USA, that they now command global respect. Infosys, one of India’s star software companies (though not the biggest) has become the first Indian company to get its equity listed in a US stock exchange (NASDAQ), and is trading at a premium over issue price.
However, the software business is a highly skilled one that will be the preserve of only highly educated people. That limits its potential in terms of employment. Of far grater employment potential is the shift of other services, notably clerical and professional services, from high-wage countries to India.
Once upon a time, the clerical work of a New York company had to be done in New York: it was too inconvenient to try anything else. But today cheap satellite communications and the internet make it possible for clerical jobs that used to be done in New York to be subcontracted anywhere in the world. Back office operations of all sorts, from billing to payroll handling, from credit appraisal to airline reservations, from inventory management to answering customer complaints, can be done in low-wage countries with no loss of time and at a fraction of the US labor cost. Indeed, by taking advantage of different time zones round the world, US companies can get clerical and professional inputs from he rest of the world while the US itself sleeps, thus raising US productivity.
The new phenomenon is still at an early stage, yet its global volume is estimated at $250 billion. Ireland has been an early star in this business, but wages there are no longer low, and jobs seem bound to move out of there. Some services have also migrated to Caribbean English-speaking countries.
The shift of service jobs to offshore centers has been called different names by different people. Some call it remote data processing. Others call it tele-working. Still others call it remote working or distance working. In India, I use a different word. Clerks in India are called “babus”. So I call the global service workers super-babus, and the sector the super-babu sector. Traditional, paper-pushing babus are unionized, unsackable, and resistant to new procedures or computerization. But the super-babus are computer savvy, anxious to upgrade their skills constantly, non-unionized, and sackable (labor laws regard them as being in the supervisory rather than worker category).
Super-babus have a good grasp of English. This is vital. The vast majority of clerical and professional work subcontracted across the globe is in the English language. And this is where India has a comparative edge over the miracle economies of Asia. The Chinese, Thais and Indonesians may be better at manufacturing, but Indians are better at speaking English. Now, I would not push that argument too far. We have at least a dozen varieties of English in India, ranging from Punjabi English to Bengali English, and many Americans would fail to recognize the accent or grammar. However, several million Indians speak well enough to be comprehensible to international companies, and that constitutes a big start. Indeed, in due course India is set to become the biggest English-speaking country in the world. Besides Indians have good skills in several professional areas ranging from engineering and accountancy to mapping and teaching. So a very wide ranges of service jobs can shift to India.
Shifting factories to poor countries involves massive investments of billions of dollars, and this is a significant hurdle. But services can shift to poor countries at low or even zero cost, simply taking advantage of existing telephone and internet connections. This has a major consequence. Only big corporations are in a position to shift manufacturing jobs to poor countries. But small companies and even individual Americans can shift service tasks to poor countries. Already US doctors and lawyers are using Indians to transcribe tape-recordings into written scripts. This means the number of potential US employers is huge, and that greatly magnifies the scope for super-babus.
GE Capital has made a start with 700 super-babus, is exhilarated at the success of the experiment, and plans to increase their number to 5,000. Bechtel has hired 400 people, mostly engineers, to provide remote on-line support to Bechtel’s projects (numbering over one thousand) in 63 countries. Medical transcription services are being offered to foreign doctors by Indian companies like Selectronic and Care Technologies.
NASSCOM’s Executive Director, Dewang Mehta, says that India already has 14,000 tele-workers earning Rs 550 crore (around $140 million), and estimates that by the year 2008 India will have 1.1 million tele-workers earning many billions per year.
Indeed, the scope for tele-working is so large that it could cause some unemployment in OECD countries and spark a backlash. However, traditional protectionism cannot be practiced here. Import duties cannot be slapped on data sent over the airwaves or through cables into US offices. Trade unions and politicians could come up with some novel ideas for barriers. Yet I suspect tele-working will be recognized as part of life in a globalized economy. I also suspect that India may get many jobs that have already migrated from the US to Ireland or the Caribbean.
Indians have for decades been working abroad (especially in the Gulf) and sending home remittances, and this is in some sense the export of services too. Technically, India is exporting the people who perform services rather than the services themselves, but to the extent the workers send remittances back to India, the money can be regarded as a service export (it is certainly not a merchandise export). Private remittances have shot up from $2.1 billion in 190-91 to $11.8 billion in 1997-98. Part of the $11.8 billion represents gold brought in by overseas Indians. If we add these remittances to other service exports, they total almost two-thirds of India’s merchandise exports.
Labor remittances are rising even without policy change. If India can persuade WTO rules to change to permit more worker movement that will increase remittances. The Gulf has fixed-term contracts, at the end of which Indian workers return home. The USA says it has no way of monitoring the movement of those who come in, no way of enforcing fixed-term contracts, and so does not permit such contracts. If some partial solution to this can found, it will greatly expand the potential for exporting Indian labor. An Indian contractor could, for instance, bid for and get the contract for garbage disposal or a construction project in OECD countries, and have to post a bond to ensure that Indian workers for the project go back at the end of it.
Medical services have considerable export potential. World class Indian hospitals already attract patients from the Middle East. But the greatest potential lies not in hospital care but in nursing care. Life expectancy will soon rise to 85 in OECD countries, and many old folk will suffer crippling diseases that leave them in need of protracted or permanent nursing care. Joshua Wiener estimated in a 1987-88 Brookings paper that the USA had 4.5 million disabled elderly in the 1980s, and will have 8 million by the year 2040. Add the disabled elderly in Japan and Europe and the total could approach 20 million. Most medical ailments last a few days, but the disabled need up to 365 days of care in the year. Wiener estimates that although Medicaid recipients needing nursing account for only 5 per cent of claimants, they use up almost as much public money as the other 95 per cent.
Nursing care in India costs a tiny fraction of care in the US. If India can set up world-class nursing institutions, and then strike a deal with US insurance companies, very low-cost insurance can be offered to folk willing to move to India for long-term nursing (this will not economic for short stays). If India attracts no more than half a million of the projected 20 million disabled elderly, that could create well over a million jobs in India.
The list of potential service exports is too long to list in full. Here are a few examples.
- Higher education. India’s Institutes of Technology and Management are recognized as world class, and their campuses now attract head-hunters searching for talent for global companies. If India can expand such centers, and perhaps use distance learning techniques in the bargain, higher education could become a significant dollar earner.
- R and D, especially in pharmaceuticals. According to a study in the McKinsey Quarterly, the cost of R and D in India is 75 per cent lower than in OECD countries. An Indian Ph.D. researcher can be hired at one-fifth the cost of an American one. Clinical trials for drugs in India should be 85 per cent cheaper than in the USA. Earlier drug companies stayed clear of India because it gave little protection to patents. Now that India has agreed to strengthen its intellectual property rights in line with WTO rules, global drug companies may be willing to shift part of their R and D to India.
- Entertainment. This is one of the fastest growing service sectors in the world. India has long made the most films per year, and has a huge music industry too, with markets in Asia and Africa. Overseas Indians number 20 million, and so constitute an export market as large as some European countries. Satellite TV has greatly expanded the ability of Indian entertainment to reach audiences abroad.
- Varun Shipping, an Indian company, has diversified into training foreign cruise ships in hospitality and catering. Such training is much cheaper in India than in the OECD.
- Hindustan Shipyard, a public sector white elephant, lost money for decades in ship-building. It has now shifted to ship repairs instead, and is doing well this area, confirming yet again that India is more competitive in services than manufacturing. . OECD countries have become throwaway societies because repairs cost too much. India is well-placed to fill the repairing space vacated by them, not only for ship repairs but all sorts of repairs (including aircraft maintenance).
The argument has some merit, but should not be overdone. Even in Asian miracle economies like Thailand or Korea, export-oriented manufacturing never employed more than a tiny percentage of the workforce, yet acted as a catalyst that made faster growth possible in all sectors. Indeed, the mere fact of being a significant player in the world market has huge beneficial side-effects in the form of a new mind-set, new attitudes towards customer satisfaction, new recognition of the importance of timeliness and reliability, up-to-date awareness of changes in technology and consumer tastes, nimbleness in adjusting to changing conditions. Many linkages exist between the export and domestic sectors. Just creating the infrastructure and streamlined procedures and regulations needed for exports tends to give domestic sectors a boost, and modern telecom has the ability to revolutionize rural opportunities. Starting an industry in rural areas has been made much simple by good communications.
Rural public call offices are already being converted by local entrepreneurs into rural internet services. This opens the possibility of abolishing all paper in government offices and putting everything on the internet at some future date, something that will greatly speed up transactions, increase transparency and hence reduce corruption. Today, villagers have to endure delays and pay bribes to get any land records or electricity connections, and even to get forms and documents for applications. Rich crooks bribe officials to tamper with and change land records. But if all records and forms are on the internet, every villager will have easy access without bribes, can download documents and forms, and will easily detect any forgery or tampering with records (a computer archive will readily enable tampering to be identified). New crop varieties can be disseminated by internet. The potential of modern communications for improving rural living conditions is enormous.
Obviously, service exports by themselves will not be enough. India needs to improve its education, infrastructure, agriculture and governance. But with all its shortcomings it has averaged more than 5.6 per cent growth for two decades. With service exports as a catalyst, it can surely sustain a rate of over 6 per cent.
