Category: Development

Pondering Outsourcing: Part Duh

I was pondering outsourcing yesterday and ran out of pondering time. Now that I have some pondering time, I thought I would continue with my pondering of outsourcing. {“ponder”: interesting word, isn’t it? Perhaps I should look it up… Here is what one source on the web says:

To weigh in the mind; to view with deliberation; to examine carefully; to consider attentively.

Syn: To Ponder, Consider, Muse.

Usage: To consider means to view or contemplate with fixed thought. To ponder is to dwell upon with long and anxious attention, with a view to some practical result or decision. To muse is simply to think upon continuously with no definite object, or for the pleasure it gives. We consider any subject which is fairly brought before us; we ponder a concern involving great interests; we muse on the events of childhood.

End of digression.}

First one point of clarification. Yesterday I wrote

Fun fact #2: Trade occurs only among two dissimilar entities. If I have an excess of peanut butter and you have an excess of bread, then we can trade and both end up enjoying peanut butter sandwiches. But if both of us have exactly the same ratio of peanut butter to bread to start off with, then we could not trade.

The point was that the two trading entities have to be dissimilar. That dissimilarity could be intrinsic or extrinsic. If they are intrinsically dissimilar, then even if their endowments are the same, trade can still take place. For instance, we may start off with the same ratio of peanut butter and bread, but you may have a strong preference for only bread and I may have a strong preference for only peanut butter. In that case, we can trade and end up happier. If we are instrinsically similar — our preferences match — then we cannot trade unless our endowments are different. End of digression number two.

Continuing with the list of fun facts, here is another. Fun fact #5: The world is moving towards increasing specialization since the stone age. Speciation is what happens in the natural world where life evolved in some primal soup and since then from the earliest protozoan to the present day different species have emerged. Evolution is a fact. The theory which explains the mechanism of evolution was given credence through the diligent and brilliant work of Charles Darwin (1809-1882). Darwin got the germ of his idea upon reading Thomas Malthus’ (1766-1834) Essay on the Principle of Population. No doubt Darwin pondered that issue long and hard and then it struck him that speciation occurs through competition for resources and those that are less fit are doomed and this process he called “natural selection”. Darwin explained the mechanism that underlies the question how did all the diversity of life originate.

It is easy to see that specialization in the economic world is a close analog of speciation in the natural world. Once upon a time you used to have people who were jacks of all trades and masters of none. Now you have programmers and playwrites, prostitutes and politicians (ok, I repeat myself), pharmacists and paleontologists. The more advanced the society, the more specialization of its work force.

Hand in hand with the specialization of the work force, we have the specialization of the firms that operate in the society. Firms that used to do all things in a particular sphere (vertically integrated firms) no longer do so. They ‘outsource’. For instance, take a car manufacterer. Once upon a time, at one end steel, rubber, and glass would go in and at the other end of the factory you would have cars rolling out of the assembly lines. All the raw materials would be transformed inside that one plant into cars. That was then. Now a car manufacturer assembles cars from components that are manufactured by other firms. So a firm that manufactures engines will supply these intermediate goods to a host of firms.

{Advanced industrialized countries (or developed countries) trade a lot amongst themselves. Much of that trade is in intermediate goods. Given that, it is hard to tell where something is really manufactured these days. For instance, ponder a complex creature such as a Boeing 777. Engines could come from Europe, parts of the fuselage from Japan, avionics from the US, … by the time you are done enumerating, you would find that practically the whole world was somehow involved in the manufacture of the plane. End of aside #18.}

That is what outsourcing is all about. You don’t do all the stuff that needs to be done. Get someone else to do it because they have a comparative advantage in doing that bit. I outsource ‘jhadu-pocha-bartan’. American firms outsource much of what they need done and a part of that outsourcing happens to be done abroad and of that work done abroad, India has a small share.

So now let’s ponder outsourcing and India. I will ponder outsourcing and the US later because I am fast running out of pondering time.

India appears to be a destination for a specific kind of outsourcing. Business processes and software development. The sort of work that does not require hard infrastructure such as roads and ports and water and power. You just need some kind of connectivity, a bunch of English-speaking graduates who can be easily trained, and a bunch of entreprenuers who would start BPO and software firms to do the ‘jhadu-pocha-bartan’ equivalent for the US firms.

From all indications, the whole business works quite well. India has a huge population. Out of that billion+ population, India graduates around a million every year. Some of these graduates can speak English and of them some are trainable. Firms that initially went into the BPO and software business had an easy time. Lots of unemployed and underemployed graduates to choose from and they had a party. Will the party continue? As more and more firms get into the game, it will become increasingly difficult to find graduates that are trainable and can speak English. Given increase in demand without significant changes in the supply, prices will get bid up. That will drive up the costs of BPO and software in India. India’s competitive advantage in the sector will deteriorate.

So how does one go about avoiding the fate that I just outlined? Simple: increase the supply. India should see that more of the million graduates it produces are capable of being trained and speak English.

For the record, I should state that while I feel happy for the people who get the BPO and software jobs, I do not feel very happy about the fact that India has to be the preferred provider of ‘jhadu-pocha-bartan’ to the Americans.

Is Outsourcing Good for the Universe

Via Rajesh Jain, I came to know of NY Times report on Paul Samuelson’s essay in an upcoming issue of JEP. I am probably one of the very few who have not read Samuelson’s celebrated book on introductory economics. That is so because I never studied undergraduate economics. My introduction to economics was at the graduate level and the first books on economics I read were Hal Varian’s Microeconomic Analysis and Bhagwati and Srinivasan’s Lectures on International Trade. I learnt undergraduate economics later while teaching undergraduate classes. OK, enough of this biographical aside.

The issue of outsourcing appears to be a very hot topic. Here is how I think about it. I go back to the basic facts.

Fun fact #1: Trade is good. Whether between two people on eBay or between two countries across an ocean, trade increases welfare. While that is true in general, there are well-known conditions under which trade can be harmful and decreases welfare. If any of those conditions exist, then you need to take corrective measures which may include the extreme measure of banning the trade.

Fun fact #2: Trade occurs only among two dissimilar entities. If I have an excess of peanut butter and you have an excess of bread, then we can trade and both end up enjoying peanut butter sandwiches. But if both of us have exactly the same ratio of peanut butter to bread to start off with, then we could not trade.

Fun fact #3: Increasing the supply of any good or service (all other things being equal) reduces its price. This is not rocket science but the ignorance of this fact is as widespread as the ignorance of rocket science.

Fun fact #4: Most change gives rise to winners and losers. Walmart in your neighborhood helps you and hurts the little stores in your neighborhood. Imported Chinese junk helps the consumers of junk but hurts the domestic manufacturers of junk. Basically, lower prices help those who consume the good or service but hurt those who produce it.

OK, so here is the story about outsourcing, the US, and India. India and US are dissimilar. Wages are lower in India as compared to the US. Why? Because wages depend on the average productivity of the country. India is a low productivity country. Why that is so is another story that we will not go into right now. Because Indian labor is cheap, producers who can use Indian labor will have an incentive to use them. If you are producing goods, you can get the goods produced abroad and sell them in the home country. Winner: the domestic consumers. Losers: the domestic workers who were replaced by cheaper labor. While labor is immobile internationally (immigration laws and all that), labor is said to be embodied in the goods that are produced abroad. Think of it as if the worker is virtually present in the US and is working for a wage much lower than the domestic worker would demand.

In the past, India supplied some goods to the US, mostly commodities. Then when communications technology improved, services could be exported. It was as if a couple of million Indians moved to the US. Increased supply immediately translates into lower prices. Basic economic logic, not rocket science at all. Lower prices help the consumers and hurt those who worked in that sector before the supply of labor increased. Globally, that movement of labor (virtual movement, of course) is welfare improving. It is undoubtedly good for India because the average wage of those workers increases and since Indians are in general not consumers of the stuff these workers produce, Indian consumers are not hurt. But is it good for the US?

What is good for GM is good for America is only true if all Americans work for GM, otherwise it is an open question. So also, if the US workers displaced by the virtual migration of Indian labor move on to more productive jobs, then the change is an unmitigated good for the US. Then of course, one has to consider the question from the temporal angle as well and distinguish between the short- and long-term impact of the change.

In the long-term (not the real long term, of course, in which we are all dead as Keynes astutely observed), Heckscher-Ohlin’s factor price equalization theorem takes effect. Here is a definition from About.com:

Factor price equalization is an effect observed in models of international trade — that the prices of inputs to (“factors of”) production in different countries, like wages, are driven towards equality in the absence of barriers to trade. This happens among other reasons because price incentives cause countries to choose to specialize in the production of goods whose factors of production are abundant there, which raises the prices of the factors towards equality with the prices in countries where those factors are not abundant. Shocks to factor availability in a country would cause only a temporary departure from factor price equality.

The basic theorem of this kind is attributed to Samuelson (1948) by Hanson and Slaughter (1999) who also cite Blackorby, Schworm, and Venables (1993). The context of the theorem is a Heckscher-Ohlin model.

Programmers and call center operators are a factor in the production of many goods and services in today’s global economy. Since barriers to trade have come down both due to free trade agreements and to technological advances in telecommunications, it has led to a “mobile” labor market for those workers. Increased supply implies lower prices for that sort of labor. Lower prices implies winners and losers, as argued earlier.

So is it good for the US and if not, could the US do something about it and if it could, should the US do something about it? Good question. The answer is forthcoming. What we have to remember when it comes to change is the good old theory of the second best which Bhagwati had written about years ago and which I believe throws light on the present debate.

India’s Real Criminals

Well, now we can all sleep soundly. Justice and reason have triumphed against the formidable forces of evil that had threatened to undermine the very basic fabric of our millennia old civilization. Our future is assured, our children can now grow up in a land of milk and honey, we can walk the streets without fear and with our heads held high. We can now proclaim with pride Mera Bharat Mahan and truly believe that India is shining.

For those who have not heard the momentous news, let me clue you in. The arch villain I am referring to is none other than Daya Nand of Narnaul (Harayana). Sixteen years ago, this enemy of humanity, committed an atrocity so immense that all the forces of the good and the holy had to be arrayed against him. But truth eventually triumphs. The Supreme Court of India prevailed and sentenced him to a life in prison and imposed a fine on this criminal as well for his unspeakable crime. Continue reading “India’s Real Criminals”

Rural Economic Development and RISC

Nobel Prize winning economist Robert Lucas had remarked that once you start thinking about economic growth, it is hard to think of anything else. What are the causes of economic growth and how can the process be enabled is a question that has obsessively occupied some of the best minds in the world of economics and commerce.

The question takes on an unparalled urgency and importance when applied to the rural Indian economy because it presents an enormous challenge, and, consequently, presents an equally great opportunity for making a difference in the lives of hundreds of millions of people. India’s economic development is predicated upon India’s rural development because around 700 million Indians live in rural India. An astonishing one out of every ten living humans lives in rural India.

Rapid progress in GDP growth and globalization in the last decade has primarily impacted the urban economy. While software exports, business process outsourcing, etc, have helped urban economic growth, it has done relatively little for the rural economy.

Without rural economic development, India has little chance of achieving growth rates required to become a developed nation. Furthermore, economic development is both a cause and a consequence of urbanization. Clearly, in the Indian context, urbanization through further rural to urban migration is both unsustainable and socially disruptive. Therefore urbanization of the rural population will have to be achieved in the rural areas.

Rural India is caught in what is called a development trap. Because of lack of economic opportunities, incomes are low. Therefore they are unable to pay for goods and services that would enable them to increase their incomes. This leads to low demand for goods and services. Consequently, firms don’t find it profitable to do business in rural India. This leads to the inadequate provision of infrastructure, which in turn leads to lack of economic opportunities, and so on.

It is important to recognize that human capital is the scarce resource globally. Fortunately India is lavishly endowed with immense human capital. However, physical capital is in relatively short supply in India. The challenge therefore is to use the limited capital most efficiently to break out of the poverty trap by integrating the rural economy with the urban Indian economy and indeed the global economy.

Various models for rural economic growth have been proposed and implemented. Vinod Khosla and I have proposed a model which harnesses the power of the information and communications technology (ICT) revolution to accelerate rural economic growth. The model called Rural Infrastructure & Services Commons (RISC) has the potential for achieving the multi-faceted goals of sustainable development. It uses limited resources efficiently by focusing them in specific locations that are accessible to a sufficiently large rural population, such as that of 100 villages.

RISC provides the benefits of urbanization by making available to rural populations the full set of services and amenities that are normally available in urban areas. It brings the benefits of ICT and the increased access to global markets that globalization promises.

The model recognizes that rural populations face a number of inter-related gaps, not just the celebrated digital divide. Bridging them simultaneously with a holistic solution is more likely to succeed than any partial intervention can.

The model facilitates the coordination of the investment decisions of the private sector, the public sector, NGOs, and multilateral lending institutions. To achieve its goal, the model strikes a number of balances &#151 between the local and the global, between planned infrastructure investment and market-driven service provision, between specialization and standardization. It does not require government subsidies for its continued operation, although the government does have a role in providing some critical functions such as risk alleviation, loan assistance, and enacting enabling legislation.

A typical RISC installation would provide services for about 100,000 rural people. These services, mostly but not all provided competitively by a large number of for-profit firms, will range from education, health, market making, financial intermediation, entertainment to government services, social services, etc. Since all services themselves require the infrastructural services such as power, telecommunications, water, physical plant, etc., large specialized firms will provide the infrastructure.

RISC obtains urbanization economies, which arise from the agglomeration of populations and infrastructure facilities. By installing RISCs to serve the rural populations of an entire state, economies of scale and scope are also obtained. Scale economies would be significant at each level of the model. At the infrastructure level, there are transaction costs associated with the necessary coordination between the firms providing the core infrastructural services. At the services level, the cost of the services will be inversely proportional to the quantity demanded and supplied.

A RISC provides a complete set of services and functions. Each service provider itself is a customer of other services co-located on the RISC. The banker uses the internet and postal services, and the internet service provider uses the banking and postal services, and so on. They make each other mutually viable and even possible. All these economies essentially lower the cost of service provision and, in a competitive market, makes them more affordable.

At a certain level of abstraction, the proximate causes of poverty can be seen as two gaps: the ideas gap and the objects gap. The objects gap is the lack of physical resources &#150 too little land, too little capital stock, etc &#150 that contribute to persistent poverty. The ideas gap is the lack of knowledge about how to make the best use of the resources available. Fortunately, the cost of knowledge goods has dropped precipitously due to the revolution in information and communications technologies. Bridging the ideas gap is a much easier task than ever before. RISC uses ICT intensively towards that end.

The transition from the concept to the actual implementation of the RISC model requires co-ordination of investment decision of the government and the large firms that provide the infrastructural elements. It is a non-trivial but surmountable challenge provided the political will and the vision exists among policy makers, private sector leaders, leading investors, and opinion makers.

Hunger in India

According to UN estimates, India has the largest number of hungry people. Over 200 million, or about one-fifth of India’s population, is chronically hungry. This is an apparent paradox in a country which is food-surplus on the aggregate. The Wall Street Journal of June 25th 2004 reports that according to Indian government sources, by 2001 India had a national stockpile of around 60 million tons of rice and wheat. It goes on to say:

But with inefficiency and local mismanagement plaguing distribution, it couldn’t move the grain fast enough through the system. Some even spoiled in warehouses. A 2002 government survey concluded that 48% of children under five years old are malnourished. That’s an improvement from three decades ago and even today, given rapid population growth, the proportion of chronically hungry Indians continues to fall. But in a sign that there are limits to the Green Revolution, the absolute number of hungry people in India began to rise again in the late 1990s, according to the U.N.

The paradox is easy to resolve if one understands one basic principle: that economic policies matter. The Indian economy has been chronically mismanaged by the Congress ever since India’s independence. And now the new Congress government could continue on the same failed path of socialism that led us to this sorry state. Vote-bank politics and the command and control license-permit-quota raj is responsible. Paul Samuelson could have been speaking about India when he wrote in April 2002 (HOW TO PROSPER IN THE TWENTY-FIRST CENTURY):

The good life does not come from dramatic speeches or boisterous parades. Where economics is concerned, so far, there is nothing in sight more promising than the limited welfare democracy where public laws harness and monitor the energies and efficiencies of the somewhat free marketplace.

It is a good time to review Amartya Sen’s book of 1982, Poverty and Famines: An Essay on Entitlement and Deprivation. Here is an excerpt from Ken Arrow’s review of the book:

In a free-enterprise economy every good or service has a price, and each economic agent starts out by owning some goods or services. The rice farmer owns some land, used for producing rice, which can then be sold on the market at the going price or reserved for use by the farmer and his family. The receipts from sales can be spent on other goods—different foods, spices, clothing, and so forth. The agricultural laborer has only his or her labor to sell; the proceeds can be spent on rice or other goods. Similarly the cities contain workers who sell labor for money to buy food, shelter, and clothing, and entrepreneurs who buy goods and labor, produce other goods, sell them, and have the proceeds for personal consumption and investment in business expansion.

People will starve, then, when their entitlement is not sufficient to buy the food necessary to keep them alive. The food available to them, in short, is a question of income distribution and, more fundamentally, of their ability to provide services that others in the economy are willing to pay for.

This, of course, does not mean that the supply of food is irrelevant. A decrease in the supply of food will usually increase its price, as people compete for the scarcer quantity. This will in turn decrease their ability to buy food by using their entitlement and, if they start close enough to the margin of hunger, may drive them to the point of starvation. Further, the entitlement approach, simple as it is, enables the analyst to say something about the distribution of the burden of starvation. Farm owners and, to a lesser extent, sharecroppers, should be less affected than others because the reduction in the amount they sell is at least partly offset by the higher prices. If the reduction in supply is caused by some factor, like flood, that reduces the amount to be harvested, farm laborers are thereby more likely to be seriously affected.

I am reminded of Oliver Goldsmith’s words from his poem The Deserted Village:

Ill fares the land, to hastening ills a prey
Where wealth accumulates and men decay

There is something rotten about India that so many people are so unconcerned about the true state of affairs. The communists are solely concerned with protecting a handful of jobs, the larger interests of the nation be damned. The government is concerned with blocking the liberalization of the economy and dragging it back to its insular autarkic pre-reform paralysis. The idiotic hype about India Shining and IT superpower crap has addled the brains of the already marginally stupid. One wonders where this is all going to lead to.

It is all karma, neh?

Tolerance and Economic Prosperity

When I feel angry about India’s lost opportunities and feel especially despondent about the Indian economy, I sometimes compare India with its neighbors, Pakistan and Bangladesh, just to get a sense of balance and say to myself “but for the grace of our un-countably many gods, goes India.” India is not ruled by intolerant monotheistic morons (an expression I picked up from the Department of Redundancy Department) — at least not yet.
Continue reading “Tolerance and Economic Prosperity”

Rajesh Jain’s article in Business Standard on Rural Economic Development

Today’s Business Standard carries Rajesh Jain’s article on Transforming rural India, the hub way in which he discusses the RISC model. Continue reading “Rajesh Jain’s article in Business Standard on Rural Economic Development”

The Cupidity of the Indian Government

Yesterday’s post about the government’s anti-Midas touch concluded with the question of what explains the sordid performance of practically anything undertaken by the government. I believe that the answer has to do with what is called the objective function of the government.

Loosely defined, an objective function embodies the goal of an economic agent and which the economic agent attempts to optimize in some sense. So for a commercial enterprise, the objective function could be to maximize market share, or it could be to maximize profits. For a consumer, it could be to maximize utility. For a government, it could be to maximize social welfare, or to minimize unemployment, etc. The objective function for a central bank could be to keep inflation below a specified value while maintaining adequate liquidity in the money markets, etc.
Continue reading “The Cupidity of the Indian Government”

The lighter side of outsourcing

Some time ago, I had posted a blog entry on the logic of outsourcing which quoted Russell Roberts of BusinessWeek Online. All very serious and good. I recently came across Dave Barry’s take on outsourcing and he does not disappoint.

The Persistence of Poverty

Economic analysis can be broadly categorized as either ‘positive’ or ‘normative.’ Positive analysis refers to the investigation of how things are, whereas normative analysis is concerned with how things should be. The former is supposed to be value-neutral whereas the latter is necessarily an expression of one’s values. A study by the UN determined that about a billion people around the world live in absolute squalor in the world’s cities and that every third person will be slum dweller within 30 years. That is a positive statement. The Guardian reports:

One in every three people in the world will live in slums within 30 years unless governments control unprecedented urban growth, according to a UN report. The largest study ever made of global urban conditions has found that 940 million people – almost one-sixth of the world’s population – already live in squalid, unhealthy areas, mostly without water, sanitation, public services or legal security.

The report, from the UN human settlements programme, UN-habitat, based in Nairobi, found that urban slums were growing faster than expected, and that the balance of global poverty was shifting rapidly from the countryside to cities.

Africa now has 20% of the world’s slum dwellers and Latin America 14%, but the worst urban conditions are in Asia, where more than 550 million people live in what the UN calls unacceptable conditions.

The emphasis on the word ‘unacceptable’ is mine. The UN in labeling something unacceptable is making a normative statement, not a positive statement. Meaning, the UN is saying that so many people living in slums should be unacceptable. Normative statements arise only in cases where the normative and the positive diverge. That is, when what is is not what should be. Here I argue that the reason that the reason so many people do live in squalid conditions is precisely because it is acceptable by all parties concerned.

Before you reject this seemingly idiotic stance, consider what it means for something to be unacceptable. If I accept something, I clearly cannot find it unacceptable. If I don’t totally and unconditionally reject it and somehow reluctantly accept it, it means that I don’t find it unacceptable. It is not ideal but it is not unacceptable either. If something were truly unacceptable, I would not accept it. So now consider the statement “550 million people living in unacceptable conditions.” They not only find it not unacceptable, but given that their numbers grow, they thrive in there. So slum dwellers find the slums acceptable in the strict sense of the word. So also, the rest of world which does not live in slums finds the existence of slums acceptable as well. If it were not acceptable, then they would have done something about it. There are ample resources in the world which if it were equitabley distributed would have resulted in a different outcome. The fact that this alternative distribution is feasible but not chosen reveals that the world as a whole prefers the unequal distribution. Therefore it is acceptable in the strict sense of the word.

I have just used what is called a revealed preference argument. If you really want to know what the preferences of an economic agent is, just note what they do rather than what they say. I don’t need to ask you whether you prefer tea or coffee at a particular time if I can simply observe you choosing tea over coffee when both were available to you. You would have revealed that you prefer tea over coffee by your choosing tea. The world has a billion people living in slums. The people of the world could choose an alternate state of being in which no one is forced to live in slums. The world chooses the former over the latter and therefore reveals its preference for the current setup.

The point I would like to stress is this: if poverty were truly unacceptable, then it would not exist given the technology and resources at the disposal of the global community. Both the poor and the rich are implied in this global community. The poor tolerate poverty as much as the rich do. I think I can explain why the poor accept poverty. I believe it has something to do with biology. The urge is for survival and therefore we adjust to unimaginably difficult conditions. People in concentration camps survive horrible deprivation. Slums are economic concentration camps. People survive. Life is Hobbesian (nasty, petty, mean, brutal, and short) but sufficiently large numbers survive so as to produce the next generation of slum dwellers. The poor breed poverty.

The rich and the powerful also tolerate poverty. If they did not, they would have mobilized against it and eradicated it. Poverty is not seen as unacceptable the way terrorism is seen as unacceptable. The US moves rapidly to spend hundreds of billions of dollars at real or imagined areas of terrorism. But it does fancy little for eradicating global poverty. A few hundred billion dollars every year would totally eradicate global poverty. But the US does not choose to wage a war against global poverty like it does against global terrorism. The rich are apparently quite comfortable with the idea of poverty. How else would one explain the persistence of poverty?