International Business 13th Edition by Donald Ball,Michael Geringer,Michael Minor ,Jeanne McNett

Exercise 3

Comparative Advantage and Offshoring of Service Jobs from the United States to India
India, a nation with approximately 1 billion people, has relatively few other resources compared with developed nations. Therefore, it should have a comparative advantage in production of goods or services that require large amounts of labor and relatively little capital. However, India has an additional comparative advantage because many of its citizens speak English (which is taught in many Indian schools and universities rather than using one of the other 18 major languages and 844 dialects spoken in the country). Thus, labor has a relatively low price due to the large Indian workforce (about 450 million, with nearly 10 million additional people entering the workforce each year), high levels of unemployment or underemployment (officially an unemployment rate of 8 percent, but a poverty rate that exceeds 20 percent), and a large proportion of rural and unskilled workers. As Internet and cellular telephone communications continue to become less expensive, India increasingly is using its English-speaking pool of labor to export services-such as software engineering, telemarketing, reviews of credit or mortgage applications, preparation or review of legal documents, analysis of blood tests and other medical services, and claims processing-to foreign companies and their customers, a process known as offshoring.
At $76 billion in annual revenues in 2010-2011, the Indian information technology (IT) industry generated more than 5 percent of India's GDP, and the overall size of this sector is projected to grow to $225 billion in revenues by 2020 as a result of factors such as declining computer prices, new tax incentives, and the Indian government's efforts to connect the country's extensive and isolated rural areas with the outside world. Fortune 500 companies such as Amazon.com, IBM, and American Express, as well as a range of more moderate-sized firms, have already offshored millions of jobs. By 2015, it has been estimated that 3.4 million U.S. jobs, representing $136 billion in wages, will have been offshored, and India is well positioned to capture much of this business. According to Noshir Kaka of the consulting firm McKinsey, "This industry can do for India what automobiles did for Japan and oil for Saudi Arabia."
For example, 1.6 million U.S. individual and corporate tax returns were estimated to have been prepared in India in 2011. Documents obtained from taxpayers are scanned and shipped electronically to India, where forms are completed and sent back to the United States to be examined, approved, and signed by an American accountant. While a U.S. tax preparer might cost more than $3,000 per month during the peak tax season, a comparable Indian worker might cost less than $300. There is no requirement that the taxpayer be informed that the tax work is done abroad, and most accounting firms charge the same fees as those charged if the job is done by accountants in the United States, thus helping to boost profitability.
Companies in financial services and insurance have also been actively pursuing offshoring. More than 80 percent of global financial services companies have an offshore facility, and the range of services being offshored is rapidly being broadened. "Offshoring has released a new competitive dynamic. Larger firms are driving change across the financial services industry and using offshoring to open up a competitive advantage over their smaller rivals," said Chris Gentle of the professional services firm Deloitte. "Offshoring is fundamentally changing the way financial institutions do business, creating a global division of labor that demands new operating models, new structures and new management skills."
"This is a global industry in the throes of flux. It is a sector where [Indian companies] are rewriting the rules of the game. That is the difference that has become apparent and increasingly accepted," says Nandan Nilekani, CEO of the rapidly expanding Indian company Infosys Technologies. The basis for this change, he says, is the "global delivery model" being pioneered in India and replicated in other low-cost nations. In the IT sector, for example, a plentiful supply of Indian software engineers can work on projects "offshore," delivering the finished product to clients "on site" in the United States. "Our business innovation is forcing rivals to redesign the way they do things."
This disruptive change is threatening to transform the business models in operation across a broad range of industries. Although many people think of low-skill jobs like telemarketing and call centers when they think of offshoring to India, the sophistication and skill levels associated with processes being outsourced are rising rapidly. A big driver for this trend is the abundance of qualified personnel in India. A NASSCOM-McKinsey study found that India has 28 percent of the overall supply of skilled services personnel in low-cost nations, and these potential employees remain amazingly inexpensive. An Indian IT engineer earns a typical annual salary of less than $6,000 and one with a master's degree in business earns $8,500-about one-tenth the level of their American counterparts, although salary inflation is starting to reduce that gap.
Services represent 60 percent of the U.S. economy and employ up to 80 percent of American workers, so it is not surprising that the offshoring of service jobs has generated concerns across a broad spectrum of society. John Steadman, president of the Institute of Electrical and Electronics Engineers, cautioned, "If we continue to offshore high-skilled professional jobs, the U.S. risks surrendering its leading role in innovation." Andrew Grove, former Chairman of Intel Corp., warned that "it's a very valid question" whether the United States could lose its dominance in information technology as a result of this trend, as it did in electronics manufacturing.
Responding to the offshoring to an Indian firm of calls from New Jersey welfare recipients about their benefits, state senator Shirley Turner said, "I was outraged. Here we are in New Jersey, as we are in every state, requiring welfare recipients to go to work. And yet, we were sending these jobs overseas... so that corporations can make more money." She noted that unemployed people do not pay taxes, and the loss of these tax revenues exacerbates budget deficits. Ironically, widespread publicity regarding concerns about offshoring may have hastened the trend by making more companies aware of the possible cost savings from such undertakings.
On the other hand, some have argued that offshoring will help to strengthen American industry and the economy as a whole. Offshoring is not necessarily a zero-sum game, where one Indian worker substitutes for one American worker. When American firms hire lower-cost labor abroad, they often must hire other workers to complement the increased level of foreign labor. Overseas expansion can also cause companies to modify the scope of activities undertaken in the United States, placing increasing emphasis on higher-value-added activities rather than the lower-skill positions that have been offshored. Shifting work to lower-cost locations abroad has the potential to lower prices in the United States, thus raising the purchasing power of American consumers, enhancing consumer spending and economic activity, and thereby creating more jobs. As The Wall Street Journal editorialized, "The world economy is a dynamic enterprise. Jobs created overseas generate jobs at home. Not just more jobs for Americans, but higher-skilled and better paying ones. At the same time, trade offers consumers a greater quantity and variety of goods and services for lower prices. David Ricardo lives."
What advantages other than profit can be gained by offshoring?