India may have solved the oursourcing issue for us

Bruce Bartlett
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Posted: May 18, 2004 12:00 AM

 The great outsourcing controversy is now over.  All you information technology workers who like to suggest that my job should be outsourced whenever I write on this topic can now put away your poison pens.  In elections last week, the voters of India fixed the problem by turning their country away from liberalism and back toward statism.  Should India's new leaders follow through on their campaign promises, there will be a lot fewer businesses there doing outsourcing or anything else.
 
For 100 years, India was the crown jewel of the British Empire.  The nation's best and brightest were often sent to British universities like Oxford, returning to India as public servants.  By 1947, when India was granted independence, it probably had the best-trained bureaucracy in the Third World.

 Two problems arose from this.  First, many of India's bureaucrats had picked up ideas about socialism while studying in Britain.  In the 1930s and 1940s, it was just about impossible to hear anything good said about the free market at a British university.  This eventually led Britain itself to adopt socialism after World War II and India's leaders were quick to follow its lead, nationalizing industry, adopting 5-year plans and all the rest of the socialist dogma of the day.

 Second, India's superb bureaucracy seemed to make socialism work.  The widespread failures of socialism in other newly independent colonies was often blamed on undertrained and unskilled bureaucrats that lacked the expertise to implement national economic planning.  To the extent that this was true, India had a leg up.  As a consequence, socialism seemed to work there for a while.

 Of course, the problems inherent in socialist planning go far beyond what even the best, most well intentioned bureaucrats can overcome.  As a consequence, Indian industry became increasingly uncompetitive, requiring higher levels of trade protection to keep it afloat.  Although the economy grew, this was mainly due to the rising population.  On a per capita basis, growth was much slower--too slow to make a dent in India's massive poverty.  Only technological advances imported from elsewhere allowed agricultural production to increase enough to avoid starvation.  The nation's entrepreneurs and professionals frequently emigrated to places where their skills earned a better reward.

 In the 1980s, India's leaders began to open up the economy just a bit.  But major reforms were not instituted until 1991, in the wake of the Soviet Union's collapse.  Industrial controls were dismantled, trade protection was reduced and foreign investment welcomed for the first time.  Previously, India had discouraged foreign capital, believing that foreign aid was preferable.  But all foreign aid did was paper over the inherent failure of planning, which allowed the country to put off liberalization for decades.

 Opening the Indian economy led to a very rapid increase in trade, from 15 percent of the gross domestic product to 30 percent by 2002.  Although the reduction in tariffs from 128 percent to 30 percent also led to a sharp increase in imports, exports increased even more.  This proves an important point always lost on protectionists.  Import barriers lead to a reduction in exports as well as imports.  Thus they often make the trade balance worse, rather than better.

 Basic trade theory says that nations will tend to export whatever they have a lot of.  In India's case, it obviously has a lot of labor.  Moreover, its legacy as a former British colony means that many of its workers are well educated and speak English fluently.  This naturally led to the establishment of many businesses providing labor-intensive high tech services, such as keying in vast amounts of data.  Also, India benefited from having many successful nationals living in Europe and America, who knew how to exploit its advantages once given the opportunity.

 Growth of the outsourcing industry led to growth of a true middle class in India.  Although wages are still much lower there than here, the gap is closing fast.  IT workers in India have seen their wages rise 15 percent per year, which is quickly eroding their cost advantage.  As a result, outsourcing companies are working harder to compete on quality and are even establishing subsidiaries in foreign countries as Indian wages become less competitive.

 The Hindu nationalist party, which had been in power since 1998, strongly supported India's high-tech industry.  But last week, it was thrown out of office by the left-wing Congress Party, which ruled India during the heyday of socialism in the 1950s and 1960s.  It capitalized on resentment by the poor against the growing middle class.  The Congress Party promised to slow reform and redistribute income.  Fearing the worst, the Indian stock market has fallen sharply since the election.

 Thus India's voters may unwittingly have solved the outsourcing problem here in a way that America's protectionists never could.