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Association for Computing Machinery

Advancing Computing as a Science & Profession

Globalization and

Offshoring of Software

A Report of the ACM Job Migration Task Force




The Association for Computing Machinery

(ACM) is an educational and scientific society

uniting the world’s computing educators,

researchers, and professionals to inspire

dialogue, share resources, and address the

field’s challenges. ACM strengthens the

profession’s collective voice through strong

leadership, promotion of the highest standards,

and recognition of technical excellence. ACM

supports the professional growth of its

members by providing opportunities for lifelong

learning, career development, and

professional networking.

For more information about ACM,

visit http://www.acm.org


For an electronic version of all or parts of this report,

visit http://www.acm.org/globalizationreport



 Globaliation and 

Offshoring of Software


A Report of the ACM Job Migration Task Force


William Aspray, Frank Mayadas, and Moshe Y. Vardi, Editors



The ACM Job Migration Task Force


Alok Aggrawal (Founder and Chairman of Evalueserve)


Frances E. Allen (Fellow Emerita at the T. J. Watson Research Center)


Stephen J. Andriole (Thomas G. LaBrecque Professor of Business Technology at Villanova

University)


Ashish Arora (Professor of Economics and Public Policy at Carnegie Mellon University)


William Aspray (Rudy Professor of Informatics and Special Advisor on Information

Technology and Professional Partnerships in the Office of the Vice President for Research at

Indiana University)


G. Balatchandirane (Teacher of East Asian Economic History and Japanese language at

the Department of East Asian Studies, University of Delhi)


Burt S. Barnow (Associate Director for research and Principal Research Scientist at the

Institute for Policy Studies at the Johns Hopkins University)


Orna Berry (Venture Partner in Gemini Israel Funds Ltd. and the Chairperson of Adamind

(LSE: ADA) Ltd. and Prime Sense, Inc.)


Michael Blasgen (Consultant in information technology)


Arndt Bode (Professor of Informatics of Technische Universität München, Germany)


Jean Camp (Associate Professor in the School of Informatics, Adjunct Professor of

Telecommunications, and Adjunct Professor of Computer Science at Indiana University)


Seymour E. Goodman (Professor of International Affairs and Computing at the Sam Nunn

School of International Affairs and the College of Computing, Georgia Institute of

Technology)


Vijay Gurbaxani (Associate Dean, Professor of Information Systems, and Director of the

Center for Research on IT and Organizations Industry-University Consortium at the

Graduate School of Management, University of California at Irvine)


Juris Hartmanis (Walter R. Read Professor of Computer Science and Engineering, Emeritus

at Cornell University)


Charles House (Director of Societal Impact of Technology for Intel Corporation)


William Jack (Corporate Vice President with SAIC and currently acting as the senior

telecommunications advisor to the Chief of IT IS at the National Security Agency)


Martin Kenney (Professor in the Department of Human and Community Development at

the University of California, Davis and a Senior Project Director at the Berkeley Roundtable

on the International Economy)


Stefanie Ann Lenway (Dean of the College of Business Administration at the University of

Illinois at Chicago, as well as Professor of Management)

Vivek Mansingh (A Country Manager for India Development Center of Dell Products Group,

Bangalore)


Göran Marklund (Science and Technology Attaché at the Swedish Offices of Science and

Technology within the Swedish Embassy in Washington DC)


Frank Mayadas (Program Officer at the Alfred P. Sloan Foundation)


Peter Mertens (Professor for information systems at the University of Erlangen-

Nuremberg, Germany)


Rob Ramer (Information security consultant)


Bobby Schnabel (Vice Provost for Academic and Campus Technology at the University of

Colorado at Boulder)


Bankim Shah (Founder and president of BRS Associates, Inc)


Marie Stella (Lead security engineer for the FAA's National Airspace Communications

Effort)


Valerie E. Taylor (Head of the Dwight Look College of Engineering's Department of

Computer Science and holder of the Royce E. Wisenbaker Professorship II at Texas A & M

University)


Takashi Umezawa (Professor of Human Resource Management in Kokushikan University,

Tokyo, Japan)


Moshe Y. Vardi (George Professor in Computational Engineering and Director of the

Computer and Information Technology Institute at Rice University)


Roli Varma (Regents Lecturer and an associate professor in the School of Public

Administration at the University of New Mexico)


Richard C. Waters (President and CEO of Mitsubishi Electric Research Laboratories

(MERL))


John White (Executive Director and Chief Executive Officer of the Association for

Computing Machinery (ACM))


Stuart Zweben (Associate Dean of Academic Affairs and Administration in the College of

Engineering at The Ohio State University)


Globalization and Offshoring of Software

A Report of the ACM Job Migration Task Force


Foreword


For the past six decades, the Association for Computing Machinery (ACM) has been an

integral part of the evolution of computing as a science and profession. In early 2004, ACM

members began expressing concern about the future of computing as a viable field of study

and work. There were daily stories in national and international media describing major

shifts in employment that were occurring largely as a result of offshoring. Combined with

the impact of the end of the dot.com boom, these reports raised more questions than they

answered in the minds of many ACM members.


Given these concerns, ACM Council commissioned a Task Force to look at the facts behind

the rapid globalization of IT and the migration of jobs resulting from outsourcing and

offshoring. Being an international organization, ACM expected the task force to look at the

issue from a global perspective, as compared to a country-centric one. This was not

intended to be a study of offshoring from the United States to India and China and the

impact of that offshoring on the computing profession in the United States. Instead, the

task force was charged with looking at the forces shaping the migration of jobs worldwide in

the computing and information technology fields. Prior to this effort, no study has looked at

offshoring on a global scale.


ACM Presidents Maria Klawe (2002-04) and David Patterson (2004-06) invited Frank

Mayadas of the Sloan Foundation, Moshe Y. Vardi of Rice University, and Bill Aspray of

Indiana University to lead the effort. This group commissioned a task force of computer

scientists, social scientists, and labor economists from around the world. The Task Force

held four in-person meetings at which the facts and data surrounding the issue were

presented and discussed. In the process, trends emerged, myths were debunked, and a

more realistic picture of the current state and likely future of the information technology

field, profession, and industry emerged.


The report resulting from this study is significant. Moreover, the annotated bibliography

available on the ACM Web site provides the most comprehensive list of reports, resources,

and papers assembled on the topic of offshoring. As described in detail in the eight chapters

that comprise the report, the field of computing and information technology has experienced

a dramatic shift in the past five years to a truly global industry. The forces that have driven

and shaped this change are still at play and will continue. The implications for every ACM

member are significant. Full participation in the systems, software, and services portion of

the global information technology field will require deep grounding in the fundamentals of

computing, new knowledge surrounding business processes and platforms, and a deeper

understanding of the global community in which work will be done. The educational systems

that underpin our profession will need to change.


The future of IT is exciting, but it is a future very different from the past, and even from

the present.


John R. White

ACM Chief Executive Officer


CONTENTS

EXECUTIVE SUMMARY AND FINDINGS........................................................... 8

INTRODUCTION ............................................................................................14

OVERVIEW ....................................................................................................19


CHAPTER 1. OFFSHORING: THE BIG PICTURE...............................................44

What Do We Mean by Outsourcing, Offshoring, and Globalization

of Software? .................................................................................................45

How Did Offshoring Come About? ......................................................................46

How Much Work Is Offshored? ...........................................................................51

Which Countries Send Work Offshore and Which Countries Do

Most of This Work?........................................................................................52

What Types of Work Are Sent Offshore? .............................................................54

Why Are Firms Interested In Sending Work Offshore? ..........................................56

What Are the Technical, Business, and Other Drivers and Enablers

of Offshoring? ...............................................................................................60

Is IT Still a Good Career Choice for People Working in Countries That Ship IT

Jobs Overseas? .............................................................................................65


CHAPTER 2. THE ECONOMICS OF OFFSHORING ............................................71

The Economics of Offshoring: Rationale and Potential Impacts ..............................71

Data on the Current State of Offshoring and Projections for the Future ..................76

Conclusions .....................................................................................................94


CHAPTER 3. THE COUNTRY PERSPECTIVE ..................................................101

The History of Software Offshoring...................................................................102

The United States...........................................................................................104

India.............................................................................................................108

China............................................................................................................119

Japan............................................................................................................122

The European Union—Western and Eastern Europe............................................124

Russia...........................................................................................................128

Conclusions ...................................................................................................129


CHAPTER 4. CORPORATE STRATEGIES FOR SOFTWARE GLOBALIZATION...134

Offshoring Firms ............................................................................................136

Overall Conclusion..........................................................................................152


CHAPTER 5. THE GLOBALIZATION OF IT RESEARCH ...................................155

Worldwide Distribution of IT Research ..............................................................159

Researcher Migration......................................................................................170

Research Job Migration ...................................................................................173

Conclusion.....................................................................................................181


CHAPTER 6. OFFSHORING, RISKS AND EXPOSURES ...................................182

Vulnerabilities: Data and Network Security and Beyond......................................183

Corporate Risks and Information Security .........................................................186

Risks to the Individual: Privacy and Identity Theft .............................................191

Risks for National Capabilities and National Sovereignty .....................................201

Risk Mitigation and Risk Assessment ................................................................207


CHAPTER 7. EDUCATION .............................................................................213

Prospects and Challenges of an Educational Response to Offshoring ....................213

Indian Education ............................................................................................216

Chinese Education..........................................................................................225

US Education .................................................................................................228

European Education........................................................................................240

The Educational Response to Offshoring ...........................................................246


CHAPTER 8. POLICIES AND POLITICS OF OFFSHORING:

AN INTERNATIONAL PERSPECTIVE..........................................................254

US Policy.......................................................................................................254

Australian Policy.............................................................................................262

Swedish Policy ...............................................................................................264

Indian Policy..................................................................................................267

Chinese Policy................................................................................................268

Conclusion.....................................................................................................270


APPENDICES

A Biographies of Job Migration Task Force Members..........................................275

B Selected Abbreviations and Acronyms ..........................................................285


Globalization and Offshoring of Software

A Report of the ACM Job Migration Task Force


Executive Summary and Findings


Why this Study?

______________________________________________________________________________________

This study reports on the findings of a Task Force established by The Association for

Computing Machinery (ACM) to look at the issues surrounding the migration of jobs

worldwide within the computing and information technology field and industry. ACM initiated

this study to provide a deeper understanding of the trends in, and the forces behind, the

globalization and offshoring of software. Because ACM is an international educational and

scientific computing society, the study approached the issue of offshoring of software from

an international as opposed to a United States-centric perspective. Moreover, the task force

that conducted the study comprised not only computer scientists (ACM’s traditional

constituency) but also labor economists and social scientists from around the world. We

believe that this approach, and this perspective, are unique. Most reports on globalization

and offshoring are produced either by governments or national organizations, and thus

provide an inherently national perspective, or by consulting firms in pursuit of their own or

their clients’ business interests.


The primary purpose of the study is to provide ACM’s 83,000 members, the computing

field, the IT profession, and the public an objective perspective on current and future trends

in the globalization of the software industry so that ACM members can better prepare

themselves for a successful future in the system, software, and services portion of the

global information technology field. We also believe this extensive study will be of value to

those shaping the policies, priorities, and investments any country must make if it desires to

remain or become a part of the global software-systems-services industry.



Scope of the Study

_______________________________________________________________________________________

This study reports on the current state of globalization and offshoring of software and

related information technology (IT) services. (Outsourcing refers to having work for a

company done by another organization. Offshoring refers to having this work done in

another country, whether or not it is done by part of the same company.)


The report is focused primarily on software systems work carried out in developing

countries for export, as opposed to work done in a developing country for their local market.

The ACM Task Force reviewed existing reports and data from around the world, and heard

in-person from many experts, on issues relevant to globalization and offshoring. In the

process, the Task Force took an in-depth look at the following:


1. The economic theories and data that underpin our current understanding of the forces

shaping globalization today and in the future.

2. Offshoring from the perspective of different countries—both developed and developing.

3. Offshoring from the perspective of different types of corporations.

4. The globalization of computing research.

5. The risks and exposure that offshoring engenders.

6. The implications for educational systems throughout the world.

7. The political responses to the opportunities and disruptions that accompany

globalization.


Each of these areas is explored in detail in a chapter of the report.


Findings and Recommendations

_______________________________________________________________________________________

In reviewing many existing reports, data, theories, and perspectives, a number of key

findings and recommendations emerged.

1. Globalization of, and offshoring within, the software industry are deeply

connected and both will continue to grow. Key enablers of this growth are

information technology itself, the evolution of work and business processes,

education, and national policies.

The world has changed. Information technology is largely now a global field, business,

and industry. There are many factors contributing to this change, and much of this change

has occurred within the past five years. Offshoring is a symptom of the globalization of the

software-systems-services industry.

This rapid shift to a global software-systems-services industry in which offshoring is a

reality has been driven by advances and changes in four major areas:

1. Technology—including the wide availability of low-cost, high-bandwidth

telecommunications and the standardization of software platforms and business

software applications.

2. Work processes—including the digitalization of work and the reorganization of work

processes so that routine or commodity components can be outsourced.

3. Business models—including early-adopter champions of offshoring, venture capital

companies that insist the companies they finance use offshoring strategies to reduce

capital burn rate, and the rise of intermediary companies that help firms to offshore

their work.

4. Other drivers—including worldwide improvements in technical education, increased

movement of students and workers across national borders, lowering of national

trade barriers, and the end of the Cold War and the concomitant increase in the

number of countries participating in the world market.

2. Both anecdotal evidence and economic theory indicate that offshoring between

developed and developing countries can, as a whole, benefit both, but

competition is intensifying.

The economic theory of comparative advantage argues that if countries specialize in areas

where they have a comparative advantage and they freely trade goods and services over

the long run, all nations involved will gain greater wealth. As an example, the US and India

have deeply interconnected software industries. India benefits from generating new revenue

and creating high-value jobs; the US benefits from having US-based corporations achieve

better financial performance as a result of the cost savings associated with offshoring some

jobs and investing increased profits in growing business opportunities that create new jobs.

This theory is supported to some extent by data from the US Bureau of Labor Statistics

(BLS). According to BLS reports, despite a significant increase in offshoring over the past

five years, more IT jobs are available today in the US than at the height of the dot.com

boom. Moreover, IT jobs are predicted to be among the fastest-growing occupations over

the next decade.

Page 10

Some economists have recently argued that in certain situations offshoring can benefit

one country at the expense of another. While debate continues about this aspect of

theory/policy, the majority of the economic community continues to believe that free trade

is beneficial to all countries involved, though some argue that globalization may lead to

technology leaders’ losing their current dominant position.

In any event, economists agree that even if a nation as a whole gains from offshoring,

individuals and local communities can be harmed. One solution to this potential negative

impact is for corporations or their governments to provide programs that aid these

individuals and their related communities in once again becoming competitive. The cost of

such “safety-net” programs can be high and, thus, difficult to implement politically.

3. While offshoring will increase, determining the specifics of this increase is

difficult given the current quantity, quality, and objectivity of data available.

Skepticism is warranted regarding claims about the number of jobs to be

offshored and the projected growth of software industries in developing

nations.

Data for making good decisions about offshoring are difficult to obtain. Government data

as collected are not very helpful and do not adequately address the specific issue of

offshoring. The objectivity and quality of other data sources, especially the data in reports

from consulting firms and trade associations, is open to question, as these organizations

may be serving their own agendas. Projections are always more suspect than data on

current employment levels.

It is very difficult to determine how many jobs are being, or will be, lost due to offshoring.

The best data available are for the United States. Some reports suggest that 12 to 14

million jobs are vulnerable to offshoring over the next 15 years. This number is, at best, an

upper limit on the number of jobs at risk. To date, the annual job loss attributable to

offshoring is approximately 2 to 3 percent of the IT workforce. But this number is small

compared with the much higher level of job loss and creation that occurs every year in the

United States.

Thirty percent of the world’s largest 1000 firms are offshoring work, but there is a

significant variance between countries. This percentage is expected to increase, and an

increase in the amount of work offshored is consistent with the expected growth rate of 20

to 30 percent for the offshoring industries in India and China. Almost all estimates are

based on reports from national and international consulting firms and, thus, subject to

scrutiny.

4. Standardized jobs are more easily moved from developed to developing

countries than are higher-skill jobs. These standardized jobs were the initial

focus of offshoring. Today, global competition in higher-end skills, such as

research, is increasing. These trends have implications for individuals,

companies, and countries.

The report considers several case studies of firms and how they are addressing offshoring,

including software service firms in low-wage nations and four types of firms in high-wage

nations: packaged software firms, software service firms, entrepreneurial start-up firms,

and established firms outside the IT sector. These cases show that the amount and diversity

of work being offshored is increasing; and companies, including start-ups, are learning how

to access and use higher skill levels in developing countries.

One example of a higher-skill area now subject to global competition is computing

research. Historically, the bulk of this research was carried out in only a few countries -

countries with high purchasing-power-parity adjusted gross domestic product (PPP GDP)

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and with a relatively large percentage of PPP GDP devoted to research and development.

This situation is changing rapidly and the trend looks inexorable. Many companies have

established research centers in multiple countries. Most of these companies retain strong

research operations in their home country. This fact, combined with increasing national

research investment in India and China, is leading to both an increase in the total worldwide

investment in research and a wider distribution of research activities around the world.

People are by far the most important asset in research. The historic advantage held by

Western Europe and the United States is not as strong today as in the past, given the

developments in the graduate education systems in China and India, increased

opportunities for research careers in those countries, and the rising national investment in

research. The United States, in particular, faces a challenge in its inability to recruit and

retain foreign students and researchers in the numbers it did in the past. Its dominance in

the research area is likely, therefore, to be challenged.

Finally, while there is no way of ensuring lifetime IT employment, there are steps that

students and IT workers can take to improve their chances of long-term employment in IT

occupations. These include obtaining a strong foundational education, learning the

technologies used in the global software industry, keeping skills up to date throughout their

career, developing good teamwork and communication skills, becoming familiar with other

cultures, and managing their careers so as to choose work in industries and jobs

occupations less likely to be automated or sent to a low-wage country.

5. Offshoring magnifies existing risks and creates new and often poorly

understood or addressed threats to national security, business property and

processes, and individuals’ privacy. While it is unlikely these risks will deter the

growth of offshoring, businesses and nations should employ strategies to

mitigate them.

When businesses offshore work, they increase not only their own business-related risks

(e.g., intellectual property theft, failures in longer supply chains, or complexity arising from

conflicting legal environments) they also increase risks to national security and individuals’

privacy. Businesses have a clear incentive to manage these new risks to suit their own

interests, but nations and individuals often have little awareness of the exposures created.

For example, many nations have adopted commercial off-the-shelf (COTS) software and

Internet Protocol technologies in IT-based military systems and critical infrastructure

systems. Many COTS systems are developed, in part or whole, offshore, making it

extremely difficult for buyers to understand all source and application code. This creates the

possibility that a hostile nation or non-governmental hostile agents (terrorist/criminal) can

compromise these systems. Individuals often are exposed to loss of privacy or identity

theft. Bank records, transaction records, call center traffic, and service centers all are being

offshored today. Voluminous medical records are being transferred offshore, read by

clinicians elsewhere, stored and manipulated in foreign repositories, and managed under

much less restrictive laws about privacy and security than in most developed countries.

These risks can be managed by companies and governments through the use of risk

mitigation strategies. For example, businesses should minimize access to databases by

offshore operations and encrypt data transmissions; offshoring providers should be vetted

carefully; companies should have security and data privacy plans and be certified to meet

certain standards; and service providers should not outsource work without the explicit

approval of the client. Nations can adopt stronger privacy policies, invest in research

methods to secure this data, or work on the development of nation-to-nation and

international treatment of both the data and how compromises will be handled.

Page 12

6. To stay competitive in a global IT environment and industry, countries must

adopt policies that foster innovation. To this end, policies that improve a

country’s ability to attract, educate, and retain the best IT talent are critical.

Educational policy and investment is at the core.

Building a foundation to foster the next generation of innovation and invention requires

Sustaining or strengthening technical training and education systems,

Sustaining or increasing investment in research and development, and

Establishing governmental policies that eliminate barriers to the free flow of talent.

Education is one of the primary means for both developed and developing countries to

mount a response to offshoring so their workforces can compete globally for IT jobs. In fact,

education has been a primary enabler of offshoring in the developing countries. India has

responded rapidly to the educational needs of its software export industry, especially

through its private universities and training organizations. China is addressing the

educational needs of its software industry through centralized planning.

There are, however, problems with both the Indian and Chinese educational systems.

India provides poor quality higher education outside its top tier of universities, the quality of

the faculty is uneven, research opportunities are not generally available to either students

or faculty, and there is a tension between providing a good education to a limited number of

people and providing access for all. The Chinese system is burdened with an emphasis on

rote learning, a reward system for faculty that has not yet been transformed fully to reward

research by faculty and their students, and problems moving from a central planning to a

competitive funding system that rewards merit and entrepreneurship.

Developed nations can use education as a response to offshoring in order to protect

national interests. It can, however, be complex for a nation to address offshoring through

education for several reasons: educational systems are complex, with multiple degrees and

multiple majors preparing one for an IT career; the nature of the software work that is

being offshored is changing rapidly; it is difficult to forecast national supply and demand

needs for software workers; governments can only indirectly affect supply and demand in

many nations; and it is difficult to translate an educational response to offshoring into

practical curriculum reform. For example, the United States educational system is still trying

to understand how to change its curriculum to address application domain knowledge, a

global workplace, and maintaining its innovative edge. In addition, the United States faces

long-term challenges from falling interest and skills in math and science programs in its

primary education system. The European Union is struggling with the implementation of the

Bologna Directive to achieve a single European educational framework.

There are some general principles that all countries can follow to mount an effective

educational response to offshoring:

1. Evolve computing curriculum at a pace and in a way that better embraces the

changing nature of IT.

2. Ensure computing curriculum prepare students for the global economy.

3. Teach students to be innovative and creative.

4. Evolve curriculum to achieve a better balance between foundational knowledge of

computing on the one hand, and business and application domain knowledge on the

other.

5. Invest to ensure the educational system has good technology, good curriculum, and

good teachers.

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Conclusion

Globalization of, and offshoring within, the software industry will continue and, in fact,

increase. This increase will be fueled by information technology itself as well as government

action and economic factors and will result in more global competition in both lower-end

software skills and higher-end endeavors such as research. Current data and economic

theory suggest that despite offshoring, career opportunities in IT will remain strong in the

countries where they have been strong in the past even as they grow in the countries that

are targets of offshoring. The future, however, is one in which the individual will be situated

in a more global competition. The brightness of the future for individuals, companies, or

countries is centered on their ability to invest in building the foundations that foster

innovation and invention.

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Introduction

In the spring of 2004 we were asked by the Association of Computing Machinery (ACM) to

chair a task force to study the phenomenon of information-technology offshoring. Offshoring

was a hot topic in early 2004. Since the dot-com and telecommunication crashes of the

early 2000s, offshoring appears to be the proverbial "third shoe" to hit the IT sector in the

United States. While articles on offshoring and outsourcing appeared in the media weekly,

sorting out facts from fiction was exceedingly difficult. While it was clear that offshoring was

a boon to providers in developing countries, debates raged on its impact on developed

countries. Getting a clear, factual picture of IT offshoring was undeniably important and

timely.

ACM offered us a free reign in conducting this study, subject to two constraints. First, the

study had to look at offshoring from a global perspective, reflecting ACM's position as an

international organization. Previous studies of offshoring have typically taken a national,

usually American, perspective. Second, the study had to be completed roughly within one

year, which implied that it had to be a secondary study, based on published material, rather

than a primary study, doing its own collection of data. Early on we decided to focus on the

software side of IT. Offshoring of IT manufacturing has been going on for a number of

years; the phenomenon that took off during the early 2000s was the offshoring of software.

Our hope is this report sheds much-needed light on software offshoring. It points out that

offshoring is a symptom of globalization, which has been an inexorable economic force since

1990, while examining the specific forces that drive software offshoring, both at the country

level and at the firm level. It surveys the debate on the economic impact of offshoring, and

examines the available data, pointing out the paucity of reliable relevant data. The report

also shows how IT research has been leading the offshoring trend. It highlights risks and

exposures to individuals, corporations, and countries created or magnified by offshoring.

Finally, it portrays the opportunities and challenges that offshoring poses to IT education in

both developing and developed countries.

The Task Force was assembled during the second half of 2004. Bill Aspray, who has

experience with work force studies, agreed to serve as executive consultant and primary

editor for this study; indeed, it could not have been carried out without him. To ensure a

broad perspective, we recruited around 30 Task-Force members, computer scientists,

economists and sociologists from the US, Europe, Israel, India and Japan (see listing below

and biographies). We are grateful to all of them for volunteering their time and efforts.

The Task Force held four meetings: in Chicago, IL, Oct. 8-9, 2004; Washington, DC, Dec.

3-4, 2004; Palo Alto, CA, March 4-5, 2005; and New York, NY, May 13, 2005. During it first

meeting, the Task Force scoped the study, decided what the main topics should be, and

divided into several committees, with some members serving on more than one. Roughly,

each committee was focused on one topic, which is covered by one chapter in the final

report. The next two meetings were dedicated to hearing perspectives by many experts and

scholars (listed below), while committees continued their work during and between the

meetings. At the final meeting, the committees presented drafts of their reports and

received feedback from the rest of the Task Force.

The committees prepared the final drafts of their reports during the summer of 2005.

These drafts went then to Aspray for editing. The edited versions were then sent to

reviewers; each chapter was vetted by several reviewers. The process of review and

revision continued through the fall of 2005.

During its work, the Task Force has reviewed hundreds of articles on the subject of

offshoring, and IT offshoring in particular. To aid the Task Force in its work, Aspray

Page 15

prepared an extensive annotated bibliography. While this bibliography is too extensive to be

included in the printed report, ACM is making it available online

(http://www.acm.org/globalizationreport) as a service to its members.

We appreciate the efforts of the many individuals who helped the Task Force carry out its

work.

Frank Mayadas and Moshe Y. Vardi

Task Force Co-Chairs, December 2005.

Contributors

The following people gave generously of their time to serve on the ACM Job Migration

Task Force, which produced this report. Biographies of the Task Force members are given

in the appendix.

Task Force Executive Committee:

Frank Mayadas (Sloan Foundation), co-chair

Moshe Y. Vardi (Rice University), co-chair

William Aspray (Indiana University), executive consultant

John White (ACM), ex officio

Task Force Members:

Alok Aggarwal (Evalueserve)

Frances E. Allen (IBM)

Stephen J. Andriole (Villanova University)

Ashish Arora (Carnegie Mellon University)

G. Balatchandirane (University of Delhi)

Burt S. Barnow (Johns Hopkins University)

Orna Berry (Gemini Israel Funds, Adamind, and Prime Sense)

Michael Blasgen (consultant)

Arndt Bode (Technische Universität München)

Jean Camp (Indiana University)

Seymour E. Goodman (Georgia Institute of Technology)

Vijay Gurbaxani (University of California, Irvine)

Juris Hartmanis (Cornell University)

Page 16

Charles House (Intel)

William Jack (SAIC)

Martin Kenney (University of California, Davis)

Stefanie Ann Lenway (University of Illinois at Chicago)

Vivek Mansingh (Dell India Development Center)

Göran Marklund (Swedish Offices of Science and Technology, Washington, DC)

Peter Mertens (University of Erlangen-Nuremberg)

Rob Ramer (TerraFirma Security)

Bobby Schnabel (University of Colorado, Boulder)

Bankim Shah (BRS Associates)

Marie Stella (US Federal Aviation Administration)

Valerie E. Taylor (Texas A&M University)

Takashi Umezawa (Kokushikan University)

Roli Varma (University of New Mexico)

Richard C. Waters (Mitsubishi Electric Research Laboratories)

Stuart Zweben (Ohio State University)

We thank the graduate students who provided research assistance to the Task Force:

Alla Genkina (Indiana University and University of California, Los Angeles)

Matthew Hottell (Indiana University)

We thank the staff of the ACM who supported this project:

Marcia Boalen

Mark Mandelbaum

David Padgham

Cameron Wilson

We appreciate the people who came to make presentations to the Task Force in

Washington, DC or Palo Alto, CA:

Josh Bivens (Economic Policy Institute)

Rafiq Dossani (Stanford University)

Ralph Gomory (Sloan Foundation)

Dan Griswold (Cato Institute)

Page 17

Ron Hira (Rochester Institute of Technology)

Lori Kletzer (University of California, Santa Cruz)

Leonard Liu (Augmentum)

Catherine Mann (Institute for International Economics)

Anita Manwani (Agilent Technologies)

Carol Ann Meares (US Commerce Department)

Peter Neumann (SRI)

Suhas Patil (Cirrus Logic)

John Sargent (US Commerce Department)

Loren Yager (US General Accountability Office)

We also thank the many professionals who reviewed a preliminary draft of sections of the

report:

Rakesh Basant (Indian Institute of Management Ahmedabad)

Allan Borodin (University of Toronto)

Erran Carmel (American University)

Lorrie Cranor (Carnegie Mellon University)

Anthony D'Costa (University of Washington)

Dorothy Denning (Naval Postgraduate School)

Peter Denning (Naval Postgraduate School)

Rafiq Dossani (Stanford University)

Ben Fried (Morgan Stanley)

Peter Hart (Ricoh Innovations)

Ron Hira (Rochester Institute of Technology)

John King (University of Michigan)

Randy Kirihara (Target)

Maria Klawe (Princeton University)

Lori Kletzer (University of California Santa Cruz)

Rich LeBlanc (Southern Catholic College)

Peter Lee (Carnegie Mellon University)

Thomas Lookabaugh (University of Colorado Boulder)

Catherine Mann (The Institute for International Economics)

Andrew McGettrick (University of Strathclyde)

J Strother Moore (University of Texas)

Sharon O'Bryan (O'Bryan Advisory Services Inc.)

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David Patterson (University of California Berkeley)

Eric Roberts (Stanford University)

Mari Sako (The Saïd Business School Oxford University)

Kevin Schofield (Microsoft)

Alan Selman (University at Buffalo, The State University of New York)

Manuel Serapio (University of Colorado, Denver)

Russ Shackelford (Stanford University)

Eugene Spafford (Purdue University)

Elizabeth Sparrow (British Computer Society)

Manuel Trajtenberg (Tel-Aviv University)

N.V. "Tiger" Tyagarajan (GECIS)

Robert A. Walker (Kent State University)

David Waltz (Columbia University)

Tim Wedding (Government Accountability Office)

Loren Yager (US Government Accountability Office)

Yoram Yahav (Technion Institute of Management)

Andrew Yao (Tsinghua University)

Page 19

Globalization and Offshoring of Software

A Report of the ACM Job Migration Task Force

Overview

1. The Big Picture

Over the past decade, low-wage countries such as India have developed vibrant, exportoriented

software and IT service industries. Attracted by available talent, quality work, and

most of all low cost, companies in high-wage countries, such as the United States and the

United Kingdom, are increasingly offshoring software and service work to these low-wage

countries. Trade (together with automation) cost many jobs in the manufacturing sector to

be lost from the West and many developing nations in East Asia to increase their wealth and

industrial prowess since 1970. Changes in technology, work organization, educational

systems, and many other factors have caused service work—previously regarded as

immune to these forces—also to become tradable. This trade in services, led by the trade in

software and IT-enabled services, presents many opportunities and challenges for

individuals, firms, and policymakers in both developed and developing nations.

Many people in the United States and Western Europe fear that sending software work

offshore will cause wage and job suppression in the high-wage countries. Others believe

that the process of getting good labor at lower prices will make the economy more

productive, enabling the creation of new wealth and new jobs. Many people in the low-wage

countries are excited by the economic development that their software and service

industries are bringing them; while some are concerned about the side effects such as

congestion, pollution, and loss of traditional cultural values. One thing that is clear is that

the globalization of software is here to stay, so that policymakers, educators, and employers

all need to address the realities of offshoring. This includes, for example, how to help people

whose jobs are shipped to another country to get assistance with their careers, how to

create innovative environments that help to create new jobs, and how to revamp

educational systems for the realities of a globalized world.

“Offshoring” is the term used here. It is a term that applies best to the United States

because, even though the United States does outsource work to Canada and Mexico, most

of its work is sent over the seas—mostly to India, but also to China, Malaysia, the

Philippines, and many other places. Germany, for example, also sends work across its

borders, including to Eastern Europe, but there is no water—no shore—to cross. Some of

the work that is offshored is sent to entrepreneurial firms established in these low-wage

countries. Other times, multinationals headquartered in high-wage countries open

subsidiaries in the low-wage countries to work on products and services for their world

market. Multinationals may also open facilities in these low-wage countries in order to

better serve the local market there, but that situation is not the primary interest of this

study.

There are at least six kinds of work sent offshore related to software and information

technology: (1) programming, software testing, and software maintenance; (2) IT research

and development; (3) high-end jobs such as software architecture, product design, project

management, IT consulting, and business strategy; (4) physical product

manufacturing—semiconductors, computer components, computers; (5) business process

outsourcing/IT Enabled Services—insurance claim processing, medical billing, accounting,

bookkeeping, medical transcription, digitization of engineering drawings, desktop publishing,

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and high-end IT enabled services such as financial analysis and reading of X-rays; and (6)

call centers and telemarketing. Our primary interest is with the first three of these

categories, which are the ones most closely associated with the transfer of software work

across national boundaries. However, it is almost impossible to study offshoring without at

least at times considering the other three categories of work as well. This is because

companies that do one of these kinds of software work may also do several other kinds of

offshore work as part of their product and service line of offerings; and companies that send

work offshore may send work of several kinds. Because companies and industries

intermingle these categories of work, so does most statistical data that tracks this

industry—and it is often impossible to disaggregate data to capture information about only

the categories of work of greatest concern here. Thus we focus on the first three categories

but discuss the others in passing.

The countries that send work offshore are primarily developed nations. The United States

followed by the United Kingdom have been the largest offshorers, but other countries in

Western Europe, Japan, Korea, Australia, and even India send work offshore. The countries

that do the work fall into four categories: (1) those that have a large capacity of highly

educated workers and have a low wage scale (e.g., India, China); (2) those that have

special language skills (e.g., the Philippines can serve the English and Spanish customer

service needs of the United States by being bilingual in these languages); (3) those that

have geographic proximity (“nearsourcing”), familiarity with the work language and

customs, and relatively low wages compared to the country sending the work (e.g. Canada

accepting work from the United States, the Czech Republic accepting work from Germany);

and (4) special high-end skills (e.g., Israeli strength in security and anti-virus software).

There are many drivers and enablers of offshoring. These include: (1) The dot-com boom

years witnessed a rapid expansion of the telecommunications system, making ample, lowcost

broadband available in many countries at attractive rates. This made it possible to

readily transfer the data and work products of software offshoring. (2) Software platforms

were stabilized, with most large companies using a few standard choices: IBM or Oracle for

database management, SAP for supply chain management, and so on. This enabled

offshoring suppliers to focus on acquiring only these few technologies and the people who

are knowledgeable about them. (3) Companies are able to use inexpensive commodity

software packages instead of customized software, leading to some of the same

standardization advantages as with software platforms. (4) The pace of technological

change was sufficiently rapid and software investments became obsolescent so quickly that

many companies chose to outsource IT rather than invest in technology and people that

would soon have to be replaced or retrained. (5) Companies felt a competitive need to

offshore as their competition began to do so. (6) Influential members from industry, such as

Jack Welch from General Electric, became champions of offshoring. (7) Venture capitalists

pushed entrepreneurial startups to use offshoring as a means to reduce the burn rate of

capital. (8) New firms emerged to serve as intermediaries, to make it easier for small and

medium-sized firms to send their work offshore. (9) Work processes were digitalized, made

routine, and broken into separable tasks by skill set—some of which were easy to

outsource. (10) Education became more globally available with model curricula provided by

the professional computing societies, low capital barriers to establishing computer

laboratories in the era of personal computers and package software, national plans to build

up undergraduate education as a competitive advantage, and access to Western graduate

education as immigration restrictions were eased. (11) Citizens of India and China, who had

gone to the United States or Western Europe for their graduate education and remained

there to work, began to return home in larger numbers, creating a reverse Diaspora that

provided highly educated and experienced workers and managers to these countries. (12)

India has a large population familiar with the English language, the language of global

business and law. (13) India has accounting and legal systems that were similar to those in

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the United Kingdom and the United States. (14) Global trade is becoming more prevalent,

with individual countries such as India and China liberalizing their economies, the fall of

Communism lowering trade barriers, and many more countries participating in international

trade organizations.

At first it was believed that the only software work that would be offshored was low-level

work, such as routine software maintenance and testing, routine business office processes,

and call centers. Offshoring suppliers, however, have made strong efforts to move up the

value chain and provide services that have higher value added because this is where there

is the greatest opportunity for profit. Research and development, project integration, and

knowledge process outsourcing such as reading X-rays and doing patent checking are

increasingly being offshored. Today, some people believe that any kind of software or ITenabled

work can be offshored. While there is an element of truth in this belief, there are

some important caveats. Some kinds of work have not been offshored. Even if it is possible

to offshore a particular type of work, it does not mean that every job of that type actually

will be offshored. In fact, there are a number of reasons why a company might not wish to

offshore work: (1) the job process has not been made routine. (2) The job cannot be done

at a distance. (3) The infrastructure is too weak in the vendor country. (4) The offshoring

impacts too negatively on the client firm such as the client firm losing control over an

important work element, losing all its in-house expertise in an area, or too high a loss of

worker morale in the client firm. (5) Risks to privacy, data security, or intellectual property

are too high. (6) There are not workers in the supplier firm with the requisite knowledge to

do the job, which happens for example when the job requires application domain knowledge

as well as IT knowledge. (7) Costs of opening or maintaining the offshore operation are too

expensive. (8) There are cultural issues that stand between the client and vendor. (9) The

company can achieve its goal in another way, such as outsourcing within its home country

or consolidating business operations.

One might wonder whether IT is still a good career choice for students and workers in

countries that offshore software and IT services work. Despite all the publicity in the United

States about jobs being lost to India and China, the size of the IT employment market in

the United States today is higher than it was at the height of the dot-com boom.

Information technology appears as though it will be a growth area at least for the coming

decade, and the US government projects that several IT occupations will be among the

fastest growing occupations during this time. There are some things that students and

workers in this field should do to prepare themselves for the globalized workplace. They

should get a good education that will serve as a firm grounding for understanding the

rapidly changing field of IT. They should expect to participate in life-long learning. They

should hone their “soft skills” involving communication, management, and teamwork. They

should become familiar with an application domain, especially in a growth field such as

health care, and not just learn core technical computing skills. They should learn about the

technologies and management issues that underlie the globalization of software, such as

standard technology platforms, methods for re-using software, and tools and methods for

distributed work.

2. The Economics of Offshoring

Much of the economic debate about offshoring centers around whether the theory of

comparative advantage applies to the offshoring of software and IT services. Economists

have argued on both sides of the issue. The arguments are sophisticated and nuanced, and

the results often depend on whether the underlying assumptions hold in the current context.

While a majority of economists are proponents of free trade, the underlying question is an

empirical one and can be answered by analyzing reliable data when it becomes available.

Page 22

The theory of comparative advantage states that if each country specializes in the

production of goods where it has a comparative (relative) advantage, both countries can

enjoy greater total consumption and well being in aggregate by trading with each other.

Offshoring enables, for example, US firms to lower costs and save scarce resources for

activities in which they have a relative advantage, while offshoring has led to significant

employment and wage gains for Indian workers and rapid profit and revenue increases for

Indian businesses.

What the theory of comparative advantage does not mean is that all members of society

will benefit from trade. In general, imports of an “input” have economic effects that are

similar to those of an increase in the supply of the input, namely, lower returns to the

suppliers of the input, lower costs of production, and lower prices for consumers. If the

input were a service, the wages and salaries of those producing the service would fall, but

so also would costs for firms that are buyers of the service. In the exporting country, the

opposite effects hold. That is, the returns to the owners or suppliers of the service or input

increase and the wages of the employees at the service providers increase due to the higher

demand.

Economists believe that trade generally leads to significant gains for society. These gains

are not inconsistent with employment losses in specific sectors that will cause economic

pain to the workers affected. To achieve an equitable result, many analysts believe that it is

important to establish a safety net that provides income and training opportunities to

affected workers. Components of the safety net might include extended unemployment

benefits, wage insurance, and retraining.

A key assumption underlying the theory of comparative advantage is that the economy

enjoys full employment. Thus, this theory is best thought of as a theory of the long-term, in

which workers displaced by imports or offshoring find work in other sectors. By contrast,

most popular discussions of the offshoring phenomenon tend to focus on questions such as

“where will the new jobs be created” and “can the workers be retrained for these new jobs”.

In general, peering into the crystal ball to predict where and what types of new jobs will be

created is both difficult and unrewarding. A dynamic economy such as that of the United

States creates and destroys millions of new jobs in response to changes in tastes, and more

importantly in response to innovations and advances in technology. There is no guarantee

that the economy will continue to create these new jobs, but policy makers can take some

comfort from the historical evidence that thus far it has managed to do so. The key to job

creation is of course the ability of the economy to rapidly generate and adopt

innovations—new types of goods and services, and productivity-enhancing process

improvements.

In general, trade stimulates innovation and economic growth in both trading partners.

Some, such as Ralph Gomory and Gregory Baumol, have argued that innovation

opportunities create new possible conflicts of interest between trading partners. For

example, insofar as offshoring stimulates, in countries such as China, innovation and

productivity growth in goods and services where developed countries such as the United

States enjoy a comparative advantage, this will cause the “terms of trade” to become less

favorable over time for the United States. In other words, even if free trade is the best

policy, it may well be that free trade, by stimulating innovation overseas, may impose longterm

losses. However, Gomory and Baumol’s analysis shows that this conflict of interest is

present when the two trading partners are at similar stages of development. Since most

offshoring involves countries at very different levels of development, this conflict of interest

is presently unlikely.

In the IT services sector, there is a related concern. Currently, it is efficient to offshore

“low-end” IT services, such as coding or maintenance, to a low-wage country while “highPage

23

end” activities, such as requirements analysis, design, and R&D, remain in the high-wage

country. The concern is, however, that eventually the high-end IT activities would also

move offshore. Were this to happen, the current technology leaders (United States,

Germany, Japan, United Kingdom, et al.) may relinquish that leadership role. There is some

anecdotal evidence that some IT process innovations are moving to low-wage, offshoring

operations.

Most economists, however, argue that current technology leaders will not lose their

technological leadership position. Even if production moves to other countries, history shows

that in many industries the locus of production and the locus of invention are physically

separated. There are two key resources required to remain at the center of innovation in

software: access to talented designers, software engineers, and programmers; and

proximity to a number of large and technically sophisticated users. Current technology

leaders, and the United States in particular, currently dominate on both counts. More

broadly, the United States has other important capabilities, including the best universities

and research institutions, highly efficient capital markets, flexible labor markets, the largest

consumer market, business-friendly immigration laws, and a large and deep managerial

talent pool. As a result, the evolution of business in the United States has followed a

consistent pattern: launch innovative businesses here, grow the business, and as products

and services mature migrate lower-value-added components and intermediate services over

time to lower-cost countries. Nevertheless, there are those who argue that globalization will

diminish the comparative advantage of current technology leaders, which may lead to the

loss of their current dominant position and create a long period of adjustment for their

workers.

Data on current and future trends of offshoring leave much to be desired. First, the

definitions of offshoring vary from one study to another, making it hard to compare

statistics. For example, some studies count all service jobs, some count IT jobs, some

include IT-enabled jobs, and some are simply not precise about what they are counting.

Second, there is a question of what metric to use in measuring the extent and trends in

offshoring. One might measure, for example, jobs lost in the developed country, jobs in the

developing country’s IT industry, or dollar value of business outsourced. In the case of each

of these metrics, however, it is either difficult to make the measurement or the metric is not

directly enough relevant to the offshoring situation. For example, it is difficult to calculate

dollar value of business offshored because these are internal transfer costs for

multinationals, which they may not be willing to report or do not report in an appropriately

disaggregated way.

Projections of future trends are more suspect than data on the current situation. One type

of projection identifies types of jobs that are vulnerable to offshoring. These vulnerability

projections provide at best a high upper bound on expected job loss, and for this reason

they are blunt policy-making tools. It may be that routine programming jobs are vulnerable

to offshoring, but it is highly unlikely that every last one of them will be lost to offshoring.

Moreover, even in cases where the methodology is sound and soundly applied, projections

of any kind about the future are much less likely to be accurate than data about today’s or

yesterday’s situation since it is difficult to predict all the factors that will come into effect

over time.

Another important issue to consider is the source of the data. Data from the United States

and many other national governments tends in general to be reliable. The US government,

however, collects data to handle established policy issues. If a new phenomenon arises, the

existing data sets may not be well suited to studying the new policy issue. This is the case

with offshoring. US data on job layoffs and on service trade are both designed for other

purposes, and there is widespread belief among economists that both seriously undercount

offshoring trends. Data collected and analyzed by trade associations and consulting firms

Page 24

may be very useful, but there is skepticism in the economic community about the quality of

these data in many cases because the methods for collecting and analyzing the data are

often not made available for scrutiny, the data they collect (from members of their

organization) may not be a representative sample of society as a whole, and these

organizations have particular objectives in mind that they hope their data will bolster.

The United States is the source of the greatest number of offshored jobs and where the

phenomenon has received the greatest attention. But even for the US, it is difficult to be

certain of the extent of offshoring. Federal data is not very helpful, and most of the existing

data comes from consulting firms. The numbers generally indicate that 12 to 14 million jobs

in the United States are vulnerable to relocation through offshoring, and that annual losses

have ranged from under 200,000 to about 300,000 service jobs from the United States to

offshoring. The number of IT jobs is somewhat lower than these estimates because these

estimates include service jobs such as working in call centers and sometimes other ITenabled

services such as business process and knowledge process offshoring. Importantly,

these estimates do not include newly created jobs. The consensus seems to be that about

20% of US companies are currently offshoring work but that the percentage is rising. The

current value of offshoring contracts from the United States seems to be in the $10 to 20

billion range, with an expectation of rapid growth. It should be remembered, however, that

we do not know the methods used to arrive at these numbers and how independent the

data from one consulting firm’s study is from that of another.

Statistics for the entire world or for other individual countries are even harder to come by

and more suspect than those for the United States. The annual dollar value of worldwide

offshoring trade for recent years has been estimated to be between $1.3 billion and $32

billion, depending on whether certain exported products are counted and whether the

numbers for multinational companies are included. An estimated 30% of the world’s largest

1000 firms are offshoring work. Europe has lower levels of offshoring than the United

States. It is estimated that only 5% of European businesses (of all sizes) are offshoring, and

at most 2 to 3% of European IT workers will lose their jobs to offshoring by 2015. The

United Kingdom has the highest rate of work sent offshore of any European nation, with an

estimated 61% of firms now offshoring. In Germany, only 15% of companies are now

offshoring, and perhaps a total of 50,000 German jobs have been lost to offshoring so far;

however, there seems to be an increase in German offshoring in the recent past. Statistics

about India show a vibrant IT industry, with annual growth of 20 to 30%, the vast majority

of the growth coming in the export rather than the domestic market. Data on the rest of the

world are too spotty to trust.

3. Understanding Offshoring from a National Perspective

The first countries to develop software industries primarily for export rather than domestic

purposes were Ireland and Israel. The big player to come in a little later was India,

beginning in the mid-1970s and growing rapidly from the late 1990s. To some degree, a

global division of labor is beginning to form: India serving the English-speaking world,

Eastern Europe and Russia serving Western Europe, and China serving Japan. But India is

also providing service to Western Europe, and China provides service to the United States.

In addition, there are many smaller supplier countries. The greatest attention is given in

this report to the United States and India, the two biggest players.

The United States has historically dominated and continues to dominate the software and

services industry, with about 80% of global revenue. It is highly dominant in the packaged

services industry, with 16 of the top 20 companies worldwide, and slightly less commanding

but still dominant in the software services sector, with 11 of the top 20 companies. This

dominance is due to a number of factors, including a legacy of government funding of R&D,

Page 25

computer science research in the open US higher education system, early adoption by

sophisticated users, the world’s largest economy and market, and leading semiconductor

and data storage industries that helped to spread the use of computing.

The centrality and dominance of the US industry has been a given during the past five

decades. What is emerging is the globalization of the software and software services

industry. This creates opportunities around the world for people and companies in both

developed and developing countries to participate in this profitable industry. It also creates

challenges for the former leaders, notably the United States, Western Europe, and Japan.

Software services is India’s largest export. As a large developing nation, India faces many

challenges, including high rates of poverty, corruption, and illiteracy; a substandard

infrastructure; excess government regulation; and various other problems typical of a poor

nation. These challenges are offset by a number of strengths, especially for software and

services production. It has a long history of developing capable mathematicians. India is

unique because of the large number of individuals with adequate English language

capability, and also for the large cadre of Indian managerial and technical professionals

working in North American and, to a lesser degree, in European high-technology

occupations and organizations. For those who can afford it, India has a strong and highly

competitive K-12 educational system emphasizing science and mathematics. Despite its

democratic socialist tradition that involved large amounts of bureaucracy and state

regulation, it has been a market economy and has a history of managerial education and

competence. These assets have given India many advantages in establishing a software

export industry.

India’s software export industry began in 1974, when it began sending programmers to

the United States to do work for the Burroughs Corporation. Political liberalizations related

to trade in the 1970s and again in the early 1990s helped to support the development of the

Indian software industry. Offering solutions to the Y2K problem helped the industry to grow

substantially. The industry expanded beginning in the late 1990s, first by bringing back to

India much of the software development, maintenance, and testing work it had previously

done on the client’s premises, then developing export businesses in business process

offshoring, call centers, and research and development. India is moving up the value chain

and is seeking people with considerably more skill than low-level programmers to do these

higher value jobs. Software and service export firms in India are growing at 20 to 25% per

year according to the best statistics available, and each of the three leading Indian software

firms (Infosys, TCS, and Wipro) already employs over 40,000 people.

India is likely to continue to grow its software industry in scale, scope, and value-added.

There is little reason to believe that offshoring as a process will end in the foreseeable

future, but it could slow down. The enormous investment by leading software multinationals

will expand the number of Indian project managers with strong managerial skills. This,

together with the relocation of portions of startup firms to India, is likely to result in greater

levels of entrepreneurship and lead to firms able to sell their skills on the global market. The

offshoring of IT services and software for export will dominate the near future of the Indian

software industry. There are several possible trajectories. Custom projects could become

more complex and large, leading Indian software professionals to move from programming

into systems integration and systems specification and design. The average size of projects

Indian firms are undertaking has already grown from 5 person-years in 1991 to 20 personyears

in 2003. As multinationals deepen their Indian operations, domain skills are

developing in India and some other nations, so that managed services are likely to become

more important; this will match global trends in the outsourcing of applications

management and business processes.

Page 26

Despite the fact that India’s software production for the US market exceeds that of any

other nation, it holds only a small share of the global market for all software value-added.

The only part of the software value chain in which India has made substantial inroads is in

applications development, where it has captured 16.4 percent of the world market. But

applications development is only approximately 5 percent of the entire global software

services market. This implies that there is much room for growth. In order to grow, the

Indian industry will have to shift to more complex activities by securing larger projects,

undertaking engineering services, integrating and managing services, or bidding on projects

that include transforming a client’s entire work process. India, however, will have some

difficulty achieving this growth unless it strengthens its R&D capability.

Software offshoring to India is likely to grow, not only through the continued growth of

indigenous Indian firms, but also because foreign software firms are increasing their

employment in India in product development and particularly in software services.

Competition is likely to grow between multinationals based in developed countries, such as

Accenture, IBM, and Siemens Business Services, and the large Indian firms, such as HCL,

Infosys, TCS, and Wipro, as the Indian companies expand their global reach and the

multinationals expand their operations in low-cost countries. The Indian subsidiaries of

multinationals play an important role in the development of India’s software capabilities,

because they are more willing to undertake high value-added activities, such as software

product development, within their own subsidiary in India than they are to send the work to

an Indian independent firm.

For at least the medium term, India should be able to retain its position of primacy for

software offshoring from the English-language world. In the longer term, unless India

makes an even greater effort to upgrade its universities and the technical capabilities of its

graduates, China may become an important alternative destination.

China’s software and services industry does not currently have a major impact on the

world economy. The industry is highly fragmented into many small companies, few of which

are large enough to take on large projects for developed nations. The hardware industry is

well established in China, and in the future it may drive the software industry to a focus on

embedded software. Unlike India, where the multinationals are focused mainly on serving

the world market, in China multinationals are more focused on positioning themselves to

serve the enormous, emerging domestic Chinese market.

Japan has the second largest software and services industry in the world, after the United

States; and it is the fastest growing industry in Japan. Japan makes games software and

custom software for the world market and packaged software for its domestic market. It

imports a significant amount of systems and applications software from the United States;

and it calls on China and India to provide custom software.

There are three typical patterns of Japanese offshoring. Most commonly, a Japanese firm

will identify a need for custom software, contract with a Japanese IT company to provide

the software, and the IT company will in turn contract with a Japanese subsidiary of a

Chinese firm to do the programming work. This programming used to be done almost

exclusively in Japan, but as the cost of locating Chinese workers in Japan has become

expensive, more and more of the programming is being done in China. A second approach

that is more recent is for Japanese firms to invest in China to form wholly owned

subsidiaries or joint ventures with Chinese firms. A third approach is for multinational

corporations to move programming and back-office functions of their Japanese subsidiaries

to lower-cost locations, often in China. The Dalian software park in China is growing rapidly

as a result of this emerging Japanese business. The amount of offshoring from Japan is still

small, but cost pressures are likely to cause it to increase; and since Japan has such a large

software industry, the opportunities for offshoring are considerable.

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The European Union represents the second largest market in the world for software and

IT services, after the United States. There are many differences, however, from country to

country, and the European Union cannot be viewed as a unified, homogeneous market. The

European software industry and employment patterns are different from those of the United

States, with much more software production done in-house and embedded in physical

products. This does not prevent offshoring, and certainly many leading European industrial

firms are establishing offshore facilities to produce embedded software. Much of this

employment is subsumed under R&D and other activities such as application-specific

integrated circuit design.

About two-thirds of the work offshored from Europe is offshored by the United Kingdom.

Continental European firms continue to lag UK firms in sending software work across their

borders. The Germanic and Nordic nations have only recently begun to build offshore

software and software service delivery capabilities, but firms with global practices such as

SAP, Siemens, and others are moving rapidly to build their offshore capabilities in Eastern

Europe, China, and India. The geography of European offshoring will be somewhat different

from that of the United States in that Nordic and Germanic firms will use Eastern Europe

and Russia in addition to India. Latin (Romance-language-speaking) Europe has been slower

to begin offshoring, but now its major firms are sending work to Romania, Francophone

Africa (particularly Morocco), and Latin America in addition to India. Despite these

geographical differences, there is no reason to believe that the pressures to offshore

software-related work will be substantially different than in the Anglophone nations. In part

this is because the US-based multinationals with strong global delivery capabilities, such as

Accenture, EDS, Hewlett-Packard, and IBM, are present and competitive in all European

markets. European firms may continue to experience a lag due to union and government

opposition to offshoring, but their cost and delivery pressures are similar to those

experienced by US firms.

In Russia, software was a relatively neglected field during the Soviet era, but in the 1990s

as the country transitioned to a market economy, many scientists and engineers moved

from low-paid government and university positions into entrepreneurial firms and Russian

subsidiaries of multinationals; and some of these people entered the software field. So far

there are relatively few programmers. Wages are low. Technical skill level is high, but there

is little project management experience. Software firms are typically small, not able to take

on large international software integration projects. Nevertheless, the high skill level of the

Russian research community, a legacy of its Soviet history, has led Intel and a few other

multinationals including Boeing, Motorola, Nortel, and Sun to open R&D facilities in Russia.

4. Understanding Offshoring from a Company Perspective

Instead of examining offshoring by country, it is also possible to examine offshoring by

the type of company. We will consider five types of firms. The first are large, established

software firms headquartered in developed nations that make and sell packaged software.

Examples include Adobe, Microsoft, and Oracle. As a general rule, the largest and most

successful packaged software firms are headquartered in the United States; the notable

exception is SAP in Germany.

Most large packaged software firms have global operations. In many cases, their offshore

operations are for localization work for the local domestic market. However, particularly in

the case of India, and also to some degree in Russia, the work is for development of their

worldwide software packages. Locating in these low-wage countries enables these firms to

have access to lower-cost programmers, many of whom are comparable in skill levels to the

company’s workers in the developed nations. This is not the only benefit. Having operations

in other time zones can speed up production by facilitating round-the-clock production.

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These opportunities are encouraging major packaged software firms to expand their

workforce in India and other lower-cost nations.

Offshoring will have a complicated effect on the packaged software firms. First, it might

and likely will put employment pressure on developed nation software firms to decrease

employment in the developed nations. On the other hand, the lower cost and faster

production could allow the development of new features in old software and could contribute

to the creation of new, well-priced software products, which would in turn increase income

for these firms and perhaps lead to greater hiring.

Next we consider large, established software firms headquartered in developed nations

that are large providers of software services. These companies may also provide packaged

software, though not all of them do so. Examples include Accenture, EDS, and IBM.

Software service firms have been among the fastest growing firms in the IT sector, and in

general they are far larger than the packaged software firms. Firms coming from the

software side (e.g., Hewlett Packard or IBM) and from the service side (e.g., Accenture) are

converging. In the case of IBM, this has been through both direct hiring and its recent

acquisition of the Indian service firm Daksh (with its approximately 6,000 employees).

Hewlett Packard has built its global non-IT services to over 4,000 persons in the last three

years, largely through in-house hiring.

Software services is in most respects a headcount and labor-cost business; these

companies grow their revenues by hiring more persons. The multinational software services

firms have been experiencing increasing pressure on costs due to competition from

developing nation producers, particularly from the Indian service giants such as Infosys,

TCS, and Wipro. This has forced the multinationals themselves to secure lower-cost offshore

labor. Service firms such as Accenture, ACS, EDS, IBM, and Siemens Business Services

operate globally, but only in the last five years have they found it necessary to have major

operations in developing nations to decrease their labor costs. Today, the larger service

firms, including Accenture and IBM, are rapidly increasing their headcount in a number of

developing nations, particularly India. At the same time, these firms are holding steady on

their developed nation headcount or gradually drawing it down. Given the ferocious

competition in software services, there is little possibility that prices will increase

substantially. This suggests that, for the large multinationals, the offshoring of services will

continue to increase in both absolute numbers and percentages of their global workforce.

Next we consider firms headquartered in developed nations that have software operations

but are not part of the software industry sector. This is the enormous and eclectic group of

companies that provide all the non-IT goods and services in the economy. Software is now

at the heart of value creation in nearly every firm, from financial firms such as Citibank, to

manufacturing firms such as General Motors. Customizing, maintaining, and updating IT

systems has become an increasingly significant expenditure for businesses in developed

countries, and thus firms are actively trying to lower these cost. One way to lower them is

to offshore the work to nations with lower labor costs.

It is difficult to estimate the amount of software work that is offshored by these

companies. Businesses often do not break out this particular kind of expense, and if work is

transferred to an overseas subsidiary, this is considered an internal transfer and may not be

reported at all. However, it is clear who does the work. If it is not an overseas subsidiary of

the company, then it is likely to be one of two other kinds of firms that provides the service:

a large service firm from a developed nation (e.g., Accenture, CapGemini, IBM, and

Siemens Business Services) or a firm from a developing nation (e.g. Infosys or TCS in India,

Luxoft in Russia, or Softech in Mexico).

It is not certain whether offshoring will lead to a decline in the number of software service

employees employed in the developed nations. In the current economic recovery, existing

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firm headcount throughout the IT sector in the United States appears to be stagnant. In

other sectors, limited data are available. For example, in financial services it is unknown as

to whether the increasing headcount in developing nations has had any impact on

employment in the developed nations. The most that can be said is that non-IT firms are

increasing their IT employment in developing nations to serve the global market, and this

trend is underway across many different firms, including industrial firms such as General

Electric and General Motors.

Next we consider software-intensive small firms, particularly startups, based in developed

nations. For small startups, offshoring is often a difficult decision, although more recently a

number of firms in the United States have been established with the express purpose of

leveraging lower cost offshore skilled engineers. For many smaller firms, an offshore facility

can be demanding on management time. This is especially true in India because hiring and

retaining highly skilled individuals is difficult. The protection of intellectual property, which is

typically the most important asset that a technology startup has, is problematic in India and

especially China. There is substantial anecdotal evidence that, despite these challenges,

under the pressure from their venture capital backers and the need to conserve funds, small

startups are establishing subsidiaries abroad, particularly in India, to lower the cost and

increase the speed of software development.

A pattern is emerging for US startups. They may initially use outsourcing to, say, an

Indian firm as a strategy, but many soon establish a subsidiary in place of the Indian firm.

They do this for a variety of reasons, including worries about intellectual property

protection, control of the labor force, and management efficiency. The minimum size of an

offshored operation is reportedly as few as 10 persons. If this report is accurate, then it

may be possible for many more small firms to establish subsidiaries in developing nations

than have done this so far. Unfortunately, data on the scale and scope of offshoring by

startups are unavailable.

It is tempting to view offshoring by startups (whether to an Indian firm, say, or to their

own overseas subsidiary) as an unmitigated loss of jobs for US workers. Nevertheless, the

real situation is more complicated. Lowering the cost of undertaking a startup could mean

that the barriers to entry are lowered, thus encouraging greater entrepreneurship. The jobs

created by this entrepreneurship should be counted against those lost by offshoring. So,

correctly estimating employment net effect of offshoring in the case of startups is very

difficult.

Finally, we consider firms in developing nations providing software services to firms in the

developed nations. The availability of capable software programmers in developing nations

provided an opportunity for entrepreneurs and existing firms to offer programming services

on the global market. It was in India where this practice first began in a significant way.

Because telecommunications links were not so sophisticated, the Indian programmers

initially were placed in the US customer’s premises. This practice was profitable and

gradually expanded to include remote provision of services – often to do Y2K work—when

telecommunication improved and demand heated up in the late 1990s. These developments

created an environment within which major corporations were willing to experiment with

overseas vendors, and a sufficient number of these experiments were satisfactory. The

result was that offshore vendors, particularly Indian firms, were validated as candidates for

software-related projects. These projects also allowed offshore vendors, again particularly

Indian firms, to grow in headcount, experience, and financial resources, so that they could

undertake larger and more complicated projects.

Software services firms from a number of the developing nations have become players in

the global economy. The large Indian firms (HCL, Infosys, Satyam, TCS, and Wipro) are at

present the global leaders. However, in China, Mexico, and Russia there are growing

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software service firms that employ between 1,000 and 5,000 people. Currently, the firms

from other nations are not large enough to compete with either the multinationals

headquartered in developed nations or the large Indian firms. Medium-sized firms in other

geographies can, however, reduce the risk for customers of having all their offshore work

done in one country, where it might be interrupted by a natural disaster or by political or

military problems. The larger multinationals and Indian firms are also establishing facilities

in other geographies, particularly Eastern Europe and, more recently, Mexico.

Firms are leading a global restructuring of the geography of software and software

services production. They are experimenting with a variety of strategies meant to utilize

workers that have become available in the global economy. This is true of software product

firms as well as multinational and developing-nation software service providers. The impact

of firms outside the IT sector with large internal software operations transferring some of

the software operations to lower-cost environments has been less remarked upon; however,

should the current trend continue, this will have a substantial effect on IT employment.

These firms have already relocated a significant amount of work from high-cost to lowercost

environments, and this process appears likely to continue, and possibly accelerate, as

firms become more comfortable working in developing nations. The offshoring of startup

employment bears particular observation because the US high-technology economy in

particular is dependent upon the employment growth that small startups provide.

5. The Globalization of Research

IT research is concentrated in only a few countries. About a third of computer science

papers come from the United States alone. A few additional traditional centers of

concentration of IT research (Australia, Canada, France, Germany, Israel, Italy, the

Netherlands, Sweden, Switzerland, and the United Kingdom) account for about another

third.

This is not surprising considering the large part of world Gross Domestic Product (GDP)

concentrated in these same countries. There is a correlation between Purchasing Power

Parity (PPP) Adjusted Gross Domestic Product and computer science publication. However,

the share of computer science paper production by scientists in the traditional centers of

concentration of IT research is more than 60% greater than their share of world PPP GDP

(65% vs 40%). In contrast, Brazil, China, India, Indonesia, Mexico, and Russia together

account for 27% of world PPP GDP, but only 7% of computer science paper production.

IT research was even more concentrated in the past than it is today. The initial bloom of

IT research occurred in a few select locations in the United States and a few other countries

in the aftermath of the Second World War. This concentration has been perpetuated by the

natural tendency of strength to build on strength. Particularly in the United States, this

bloom was driven by ample government funding and a significant migration of scientific

talent from the rest of the world. In fact, there is little doubt that government funding has

played an important role in most countries. For example, on a per capita basis government

funding is significantly larger in Sweden and Israel than in the United States. The pattern of

strength in only few countries is amplified by a general migration of scientists from

countries that do not support graduate education and research to countries that do.

Research-driven innovation is seen by many countries as a way to increase national

wealth and standard of living. Both developed and developing countries are attempting to

build up or shore up their research capabilities. This means greater competition among

nations in the research area, and in particular competition for talent. Until recently, the

United States had won the research talent competition, but that situation is changing. Due

to strong efforts to foster research on the part of a number of national and local

governments outside the traditional centers of research, IT research is slowly but steadily,

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and almost certainly inevitably, becoming more global. This globalization of IT research has

been accompanied by a significant increase in the production of PhDs outside the traditional

centers of concentration, and a reduction in the migration of researchers to these centers.

In the long run, there is no obvious reason why IT research should be any more

concentrated than world economic activity in general.

Globalization allows more and better people to participate in IT research. Increasing

educational opportunities around the world means that more people are able to realize their

research potential, thereby increasing the size of the IT researcher pool and the quality of

the best researchers. A freer worldwide market in research means that potential funding for

IT research can more easily be targeted to those that can most effectively and efficiently

create research results. Both of these trends increase the amount of scientific advance that

can be obtained from a given level of resources. There is little doubt that this is good for the

field of IT and for the world as a whole; however, while we gain as a group, localities and

individuals may end up suffering losses.

Globalization provides improved opportunities for people who live outside the traditional

centers of concentration of IT research. It also provides improved opportunities for the best

researchers, due to increased global competition for their services. It may, however, limit

opportunities for other researchers in the traditional centers of concentration, for whom

global competition may mean declining wages or even the loss of jobs.

6. Risks and Exposures

Businesses that make offshoring and outsourcing decisions increase their own exposures

to risk, and at the same time potentially create additional risks and exposures at many

other levels, all the way from individuals to nation-states. Many of these other communities

of interest have scant awareness that they are being exposed. For every risk of privacy

invasion into an employee database that an employer might fear, data about ordinary

citizens is exposed to tens of risks. Bank records, transaction records, call center traffic, and

service centers are all offshored today. Voluminous medical records are being transferred

offshore, read by clinicians elsewhere, stored and manipulated in foreign repositories, and

managed under much less restrictive laws about privacy and security than in most

developed countries. The higher exposure to terrorist incursion, sabotage, or extortion

attempts has not received wide discussion by companies employing offshore labor.

A basic principle of security is that the longer the supply chain and lines of

communication, the more opportunity there is to attack them. The inherent difficulties in

international data communications are compounded by jurisdictional issues regarding

regulation and legal responsibility. Offshoring risks include data communications

vulnerabilities, loss of control of business processes, loss of control over network

perimeters, increased network complexity, clashing security policies and procedures, gaps in

personnel security, and drastically diminished ability to know about and respond to security

breaches.

What seems particularly lacking within many procuring companies is an overall line of

authority and responsibility for primary data records as they pass through one, two, or more

subsequent offshore companies that perform work on the data set or perform operational

tasks for one purpose or another. Such “hands-off” management responsibility cannot be

presumed to work in the best interests of anyone concerned with risk attenuation.

Risks turn into incidents through two basic kinds of action—accidents and intentional acts.

The vast majority of incidents that can be anticipated originate with threat actors: rogue

employees, hackers, criminals, organized crime syndicates, industrial espionage, unfriendly

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nation-states, and terrorists. Effective risk management strategies include security due

diligence, business due diligence, active risk management, and third party auditing.

Commercial risk from offshoring is multi-faceted and different from security risk. Business

issues are primarily operational—concerning productivity, efficiency, and quality. Business

managers everywhere struggle with costs, delivery times, and product quality. Geographic

and cultural spread can adversely affect the latter two even as costs seem to be reduced.

Communication paths become longer and more convoluted; they are more apt to suffer

distortion and error from language and cultural difference. Supply chain networks become

more diverse, less centralized, and hence less controlled. Protection from manufacturing

sabotage and theft becomes more difficult because of the breadth of the system.

Intellectual property protection becomes more porous as the infrastructure expands on an

international scale. Legal barriers and costs increase as companies cross international

boundaries, due to conflicting regulations, procedures, and practices. Safety issues are

exacerbated by decentralized operational logistics.

The most contentious and perhaps most challenging aspect of offshoring is its risk impact

on individuals. Individuals are often pawns in this global restructuring of business. They are

at risk of loss of privacy, loss of jobs, loss of property through identity theft and credit card

fraud, and loss of security. Moreover, they have little say in these business decisions and

little they can do to protect themselves.

Offshoring adds threats and vulnerabilities that do not exist in domestic outsourcing, and

increases vulnerabilities that exist in all inter-network commerce. Multiple legal jurisdictions

add new risks. Distance adds complexity and vulnerability because cyber-space is actually a

complex of real-world service providers in distinct jurisdictions with varying cultures, all

under cost pressures. A company acting under a business culture not easily known to clients

cannot be assumed to be exercising all the same precautions that might be common

practice in the client business’s country. As more and more countries provide offshore

services, the price pressures on providers of outsourced services increase. With increased

price pressures, the temptation to skimp on security measures gets stronger.

There are a number of steps that can be taken for protection. Data that is being

transmitted should be encrypted. Offshoring providers should be vetted carefully.

Companies should have security and data privacy plans and be certified to meet certain

standards. Service providers should not outsource work without the explicit approval of the

client. Mass export of databases should not be permitted. Data should be accessed one

record at a time and on a need-to-access basis. The database should be encrypted. Certain

types of data should not be allowed to be exported across national boundaries.

Offshoring can also place national security at risk by threatening both military and critical

infrastructure operations. For example, the United States and other countries’ IT-based

military systems have adopted COTS (Commercial Off-The-Shelf) product purchasing

strategies, shared national and international commercial infrastructures, and Internet

Protocol technologies to facilitate network-centric warfare systems. It is more difficult for

the buyer to gain insight into source and application code documentation for COTS products,

especially if the providing companies are offshore. Many COTS components and sometimes

whole systems are developed and maintained by providing companies, which may

themselves procure development and services from other nations with privacy, intellectual

property rights, security, diplomatic, and defense policies possibly at odds with the original

procuring country. Thus, a COTS strategy increases the possibility of a hostile nation or

non-government hostile agents (terrorist/criminal) being able to compromise the system or

services. Attacks can cause malfunction and destruction of critical infrastructure such as

transportation, power, and financial systems, and loss of citizen confidence in their

infrastructure and government.

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The offshoring of homeland security technology development and management systems

that send vital information such as biometrics, identification codes, tax and personal

information overseas are of critical concern. Until better controls of this information are

developed, this presents a risk to all nations. Further research in methods to secure this

data and the development of nation-to-nation and international treatment of both the data

and how compromises will be handled is vital.

Globalization is here to stay and so are its international effects. National security and

social effects can never be completely mitigated, but country-specific and international

strategies can be put in place. Problems cannot be solved until they are defined and

accepted as valid by a sovereign entity and its citizens. Topics needing national attention

include legislation, international agreements, policing, tariffs, Internet policies, and more

equitable tax-structure strategies for companies investing at home. Other topics needing

public attention include more formal government-commercial agreements and funded

research to address data protection and communications between stakeholders involved in

homeland defense and critical infrastructure.

7. Education in Light of Offshoring

Offshoring creates major changes in the demand for workers. Some countries need more

workers, others fewer. Offshoring also causes the set of skills and knowledge of workers to

change. Education is a tool that enables a country to provide the skilled workers that it

needs, and thus it can be the centerpiece of a national policy on offshoring. Developing

countries that are building up their software service export markets, such as India and

China, need to prepare growing numbers of people to work in this industry. The developed

countries are facing questions about how to revise their educational systems to prepare

their citizens for the jobs that will remain when other jobs have moved to lower-wage

countries. These developed countries also have to find ways of making their education

system serve to increase the technological innovation that has historically driven

productivity gains, new employment, and new wealth for nations.

The United States has a well-established and complex IT educational system. The

bachelor’s degree is the primary degree for people entering a computing career. While

degree programs appear under many names, five majors cover most of the programs:

computer science, computer engineering, software engineering, information systems, and

information technology. Although there are some differences among these five types of

programs, they are many similarities in providing foundational knowledge related to

computer programming, the possibilities and limitations of computers, how computers and

computing work in certain real world applications, various skills about communication and

teamwork, and other topics.

In addition to the five traditional kinds of departments, a variety of new academic units

related to computing and information technology have begun to emerge in US universities.

These include schools and colleges of computing that typically include the degree programs

in computer science as one component, new schools that are separate from computer

science and information science programs that fill an additional need in the computing and

information technology space, information schools that in almost all cases evolved from

library schools, and campus-wide multidisciplinary information technology institutes aimed

at fostering collaboration of faculty and students across departments. While they are not the

programs intended to produce ace programmers or deep technical experts, the mix of skills

and perspectives is a reasonable educational experiment to try to produce students well

suited for higher-value-added jobs. There is also rapid growth in degree programs offered

by for-profit universities, which provide a convenient entry to the profession for working

adults.

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Non-degree programs also play an important role in US IT education. They include

certificate programs, non-degree courses offered by traditional colleges and for-profit

organizations, training associated with specific technologies, and corporate training

programs. These alternative kinds of training programs appear to be growing rapidly, but it

is difficult to quantify their extent or growth. There are many different goals being sought

through enrollment in these non-traditional programs: training for a specific IT career,

career advancement within the IT field, move from a non-professional to professional IT job,

continuing education to keep technical skills current, or gaining specific product information

or usage skills. There is also training provided by corporate universities for employees,

customers, and suppliers, which might include technical training, background information

about the company or its industry, or core competencies such as learning skills,

communication and collaboration, creative thinking and problem solving, global leadership,

or career self-management.

Recent changes in Europe, under the Bologna Declaration, have the goal of unifying the

European educational system along the lines of American system of separate bachelor and

master degrees. The Bologna process provides a standardized sequencing of degree

programs, makes it less time consuming to obtain the first undergraduate degree, and

makes the system more open for students who received their baccalaureate degrees in

developing nations to enter masters programs without having to repeat some of their earlier

training. The Bologna initiative has stimulated new interdisciplinary and specialized studies

in computing within European universities, especially those incorporating domain-specific

knowledge such as bioinformatics and media-informatics, and has also created separate

programs in software engineering and telecommunications. The increasing uniformity of IT

education across Europe will provide additional incentive for offshoring work from higher to

lower wage countries within Europe; in the long run it may lead to a leveling of IT wages

across Europe.

The German model is particularly important since the German-speaking nations represent

approximately a quarter of the European population. There are some major voices in

Germany in opposition to the Bologna initiative. For example, the T9 initiative, by the nine

largest and leading technical universities in Germany, argues that the traditional model of

university education leading to a diploma after nine semesters has considerable advantages

over the system that leads to separate bachelor’s and master’s degree. It is unclear whether

this will lead to modifications in the Bologna model over time.

India, as the largest supplier of exported software services, faces a different set of

educational challenges from the United States or Europe, namely to ramp up its higher

education system to staff its rapidly expanding software industry. Soon after India achieved

its independence in 1947, a decision was made to invest a greater amount in higher

education than is typical for a developing nation, even though there was not enough money

to finance primary education for all. This decision was taken in part to support the efforts to

build an educated workforce for the heavy industry that India’s leaders envisioned would

provide an important part of its revenue base. The investment in higher education was

advantageous to India when it opened up its markets and began to participate more

extensively in global trade in the early 1990s. There have been many competing claims on

government funds, and the central government has not been able to keep up with the

increasing demand for higher education. Policies were liberalized in the early 1990s,

allowing the formation of new private institutions of higher learning, resulting in the rapid

development of private postsecondary education. Whereas only 15% of engineering seats in

university had been at private institutions in 1960, 86% are private today. The rapid

advancement of the private university system has created some problems. Quality varies

widely, from clearly substandard to the highest international quality, and the government

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has not established, much less enforced quality standards. Some Indians also object to the

high tuition and fees as being counter to the equal access goals of the nation.

Today the higher education system in India is extensive and rapidly expanding. It

currently includes more than 300 universities, 15,000 colleges, and 5,000 training

institutions. Nevertheless, only 6% of the college-age (18-23 year old) population is

enrolled in college or university. Some of the schools, such as the Indian Institutes of

Technology and the Indian Institutes of Management are world-class; but the quality falls

off rapidly after the top 15 schools. Total bachelor and master degree production in the

computing and electronics fields is approximately 75,000 per year. There are also some

350,000 students in other science and engineering fields at universities and polytechnics

receiving degrees each year, and many of them enter the IT industry upon graduation.

Training in the latest technology, English-language skills, and other work-oriented topics

are also important to the Indian software industry. This training is offered both by many

independent training organizations and some of the large IT companies such as Infosys and

Wipro, which run their own training operations.

China faces the same educational issue as India in building a trained workforce for its

software industry, but its approach is different, through centralized planning. When the

Communist Party came to power, it was committed ideologically to education and the use of

science and technology for economic development. Upon the establishment of the People's

Republic of China in 1949, the Western powers pursued a policy of isolating China; a byproduct

of this was China’s adoption of the Soviet Union’s model of comprehensive and

specialized universities and a large network of research institutes. In 1978, the Chinese

university model was reformed to one that more resembled that of the United States and

emphasized comprehensive universities. In the 1980s, China began sending many of its

brightest science and engineering students to the West, especially to the United States, for

graduate education. Nevertheless, the government research institutes within China are still

enormous and play an important role in graduate education. Until recently, only a very few

universities undertook research; their highest priority was pedagogy.

As in the case of India, Chinese universities graduate an enormous number of students

every year. In 2001, 567,000 students received their first degree, including 219,000 in

engineering and 120,000 in science. The quality of these graduates varies dramatically, but

the sheer volume means that China has a large reservoir of technically trained individuals.

Until 2001, Chinese universities neglected software studies as an academic discipline. At

the end of the 1990s, the Chinese government recognized that it had a shortage of trained

software personnel and called for improvement in Chinese software capabilities as part of its

central planning efforts. In response, 51 Chinese universities established masters degrees in

software engineering. These degree programs quickly attracted students. Including all the

different kinds of curricula, China is now training about 100,000 people per year for the

software industry. There are internal criticisms of the education, including overemphasis on

theoretical education, insufficient attention to practice, and lack of familiarity with

international standards.

There are many challenges to implementing an educational response to offshoring.

Consider the challenges in the United States. IT work encompasses many different

occupations, each with its own skill and knowledge requirements. There are five major types

of undergraduate degree programs in IT, and each would require revision in order to

address offshoring. There are similarly four different degree levels (associate, bachelors,

masters, and doctorate) to revise. Non-degree programs, such as certificate programs,

corporate training, and non-traditional universities all also play an important role in

preparing the IT workforce. There are multiple career paths in IT to take into consideration,

not just the traditional one from a college degree to a career in the same field. Universities

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are slow to make changes in their employees and their course offerings. It is hard for

national bodies to predict and match supply and demand for the IT workforce, so it is hard

for the higher education system to know how to set its production levels. The mission of a

university is not only to prepare tomorrow’s workers; there are other goals such as

research, preparing tomorrow’s teachers, giving students a liberal education, and teaching

them to think critically that must be considered when revising a university’s program to

address workforce needs. Offshoring itself is rapidly changing (from bodyshopping, to call

centers, to business process outsourcing, to knowledge process outsourcing and other

higher value added tasks), so how is a higher education system to know what occupations

to prepare its students for? These challenges mean that educational systems will have to

continually adapt to serve well their students and countries in the face of increased

globalization.

Although the educational needs and issues may look different from different national or

individual perspectives, this study has identified six overarching principles that should apply

in developing as well as developed countries wishing to participate in the global software

industry.

There is a need to consider the levels of IT work that are predominant in the national or

multinational economy being served by the educational institution, and which are likely to

be predominant in the coming years. Software and IT work can be thought of as consisting

of a spectrum from the more routine (e.g. system and computer maintenance and support,

basic programming) through the more advanced (e.g. application programming that

requires knowledge of IT and specific applications, whether business, science, media or

otherwise, or sophisticated systems programming and IT architecture development) to the

advanced strategic (development of approaches that utilize IT to advance the organization

strategically and provide it with a competitive advantage). As computer science and IT

curricula are developed, particularly at the national level, it is important to consider the

levels of workforce preparation to which the curriculum is addressed. In nations that are

current recipients of offshored work consisting of programming and routine software testing

and maintenance, for example, it may be desirable to focus the curriculum more heavily on

the lower levels. This may change, however, as the roles played by IT professionals in these

countries evolve and the offshoring providers aim to perform higher level work. In countries

that are seeing their commodity IT work being offshored, it will be desirable for the

curriculum to prepare students for the middle and upper levels of IT work, where the ability

to merge computer science and IT with applications and strategy are important. This is

likely to lead to an increased emphasis on application knowledge and a reduced emphasis

on programming skills. It should be stressed that in all cases, however, the predominance

of a certain level of IT work in a certain nation or region is just a generalization; all levels

will exist in all countries, and students will be needed to move into all of these levels. It is

the distribution that will vary.

There is a need for CS education to evolve, whether due to globalization or not. The skills

and talents needed by software and IT professionals have evolved over the past half

century, independent of issues such as outsourcing and offshoring. In general, IT

professionals are more likely to work in an application-specific context than previously, and

conversely, less likely to work on computer-specific areas such as compiler or operating

system development. They are more likely to work on large software applications in teams

that include applications specialists, and depending on the organization, also to collaborate

with sales and marketing staff. They are also more likely to work in an environment where

they are expected to be masters of certain software platforms and interoperability

standards, and know how to reuse code. Thus in general, it will be increasingly important

that a computer science or IT education involves training that enables the student to work

on large-scale software applications, to understand important business, scientific, or other

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application areas, and be familiar with the tools and platforms that are increasingly the

standards in the international marketplace. It also is increasingly important that the

education emphasizes teamwork and communication skills, especially as they are practiced

in a geographically distributed fashion.

There is a need for education to begin to prepare students for a global economy and its

possible impacts on their careers. It is increasingly likely that an IT professional will be

working in a global context. This may include being part of a multinational team, or

collaborating with customers or suppliers from other parts of the world. Thus, it will be

increasingly important that an education in computer science and IT help prepare students

for this global workplace. Education that acquaints students with different languages and

cultures, whether through courses, study abroad, or other means, will be increasingly

beneficial. Finally, to the extent that English is the common language of the IT industry, the

ability of nations to educate their IT professionals to be fluent in English will be a major

factor in determining their success in the outsourcing economy and in multinational

endeavors.

Educational systems that help prepare students to be creative and innovative will create

advantages for those students and their countries. As the lower tiers of software and IT

work become more commoditized, creativity and innovation will become even more

important, particularly in countries that experience the loss of support and programming

work. The creation of new products and new businesses will continue to lead to the greatest

commercial and scientific successes, and even more, become the differentiator between

organizations and between nations. Historically, some educational systems are seen as

fostering creativity in students more successfully than others. One crucial differentiator in

fostering a creative mentality in students is the research component of the educational

system, and the participation of students at all educational levels in the university’s

research enterprise. Another differentiator is the degree of rote learning versus more open

problem solving. Nations that currently have an advanced research enterprise in their

university systems may increasingly see this as their greatest competitive advantage in

educating computer science and IT students for the higher tiers of the IT workforce. Nations

that do not include a research component in their university systems will need to consider

whether, strategically, the investment in developing this component and culture is needed

to attain their goals for the IT economies in their countries.

Educational systems that not only pay attention to current business and industry needs

but also provide a core foundational knowledge will create advantages for those students

and their countries. To cite two national examples, the Indian educational system has been

particularly good at teaching the latest technology that is needed in business and industry

today. The United States has been particularly good at teaching foundational knowledge

that is likely to serve a student through most of his or her career. Foundational skills help

students remain current, and not become obsolescent, as the technology changes rapidly

around them. Although the particulars of a new technology in the workplace may be

different from what a student was taught in school, a basic understanding of computing

principles and ways of addressing problems will remain current even as the particular

technologies change. Of course there needs to be a balance between fundamentals and

currently relevant technologies in the student’s education. In order to prepare students to

be productive workers when they enter the job market, it also is important that the

educational system pay attention to the current needs of business and industry and select

the technologies it exposes students to in order to address industry needs. This goal can be

achieved through respectful interchange between people in the academic and

industrial/business worlds. No IT education can possibly fulfill all of the student’s

educational needs for an IT career, however, and IT workers should expect to have to

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engage in life-long learning in order to keep up with the rapid pace of technological change

and the rapid changes in the way that organizations employ information technology.

A good educational system requires the right technology, a good curriculum, and good

teachers. Fortunately, personal computers are relatively inexpensive, software for them has

been commoditized, and fast, inexpensive broadband communication is readily available

most places in the world. Thus, the technology for training an IT workforce is within reach of

much of the world. The model curricula that have been designed by the professional

societies have been and should be used in many places around the world. There is probably

value in developing a process by which these curricula can have greater business and

industrial input and react more rapidly to changes in the way that IT gets used in the world.

Although adopted around the world, the model curricula have been designed primarily for

degree programs in the United States. If the professional societies truly aspire to be world

bodies and develop world curricula, they should pay attention to the needs of other

countries and their degree programs as well. The teacher problem may be the most difficult

one to address. For example, in the United States, there are serious problems with the

preparation of high school teachers who introduce students to IT, and several times in the

past (in the late 1970s and again during the dot-com boom of the late 1990s) American

universities had difficulty recruiting and retaining quality faculty because of the lure of

industrial IT positions, and had inadequate number of students obtaining doctorates, which

are required to become faculty members. In India, critics complain about the general quality

of IT faculty, salaries are low, and there have been no funds to enable research either by

the faculty members or their students. Inducements to improve the quality of the faculty

would be helpful in India, the United States, and other countries.

8. The Politics of Offshoring

Globalization, especially in its manifestation as offshoring, is a hugely disruptive force that

effects the national movement of wealth and jobs. In addition to the educational responses

to offshoring discussed above, countries might adopt political responses. Developed nations

might take political action to stem the loss of jobs and wealth to globalization, either

through protectionism or measures to make the country more competitive. Developing

nations might take political action to create an environment in which its software export

industry can flourish. Our initial focus here is on the United States, which is largest global

offshoring procurer.

Public policy debate about offshoring began in the United States as a result of the wide

news coverage of the report in November 2002 by Forrester Research that 3.3 million US

jobs would be lost by 2015 as a result of offshoring. The most common response to

offshoring in the United States has been actions by the executive and legislative branches of

the state and federal governments to create protectionist laws and executive decrees to

control the movement of work out of the country. Bills have been introduced that limit the

citizenship or visa status of workers allowed to do work for US organizations or require that

call center operatives working outside the United States inform callers of that fact. There

are reasons to question the legality and efficacy of this protectionist legislation. Some legal

scholars believe that most proposed state laws and executive orders will be ruled

unconstitutional because of the Commerce Clause of the Constitution, which leaves control

of international commerce agreements in the hands of the federal rather than the state

governments. Legal scholars also believe that proposed federal legislation on offshoring may

break existing international agreements. There is also a risk of retaliation by other countries

to protectionist American legislation.

A second policy approach has been to propose reforms to the H1-B and L-1 worker visa

programs. The purpose of these programs is to help US companies find skilled workers, but

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critics claim that they are being misused as part of a strategy that enables companies to

export jobs, especially to India.

A third approach is to ensure that US tax law provides no incentives to moving jobs

overseas. These proposals would normalize tax rules between the United States and other

countries so that US-based multinationals will have incentive to repatriate earnings to the

United States that they earn in other countries. Tax law is hard to enact; and even if it were

enacted, there would still be disparities because of costs of health care, safe workplace

legislation, and environmental protection.

A fourth approach has been directed at providing support to Americans who lose their

jobs through offshoring. In 1962, the US Congress passed the Trade Adjustment Assistance

Act to offer job training and extend the length of time of unemployment benefits to

American workers who have lost their job through trade agreements. There has been a

political and legal battle over whether the Trade Adjustment Assistance Act does or should

apply to software workers. Progressives want to go beyond this act and also require

companies to provide three months of notification to workers whose jobs are to be

eliminated because of trade, extend the term length of unemployment benefits, provide

wage insurance paid for by the companies that offshore work to make up some of the drop

in wages typical in the displaced worker’s next job, improve retraining and reemployment

services, offer temporary health care and mortgage assistance, and allow multi-year income

averaging on federal taxes.

A fifth approach is to improve the innovation base. The basic idea is that, although some

jobs will undoubtedly be lost to low-wage countries, America can produce a substantial

number of new jobs, including many of them that are high on the value chain, through

policies that create a climate of innovation. Innovation policy generally has four elements:

making it more attractive for foreign students and scientists to work in the United States,

improving the educational system in the United States, attracting US citizens to the science

and engineering disciplines, and increasing federal support for research and development.

There have been numerous criticisms that the United States is not now doing enough to

build that innovation base, and there are proposals under discussion by both Democrats and

Republicans in Congress, as well as suggestions from various non-profit organizations, to

create new innovation initiatives.

How do policy issues in other countries that offshore work compare to those in the United

States? Australia presents an interesting case study in the politics of offshoring in that

Australia offshores work but is itself a country that has benefited greatly from free trade,

both in terms of its important export markets for wheat, wool, coal, wine, education, and

tourism, and also for the range of products that are available to its citizens through imports.

Debates over free trade arose in Australia over offshoring in 2004. There was sharp

criticism from the opposition Labor Party to the lack of policies protecting Australian jobs

and workers. Interestingly, the Australian Computer Society published a policy paper that

advocated free trade and resisted any protectionist measures. Instead, it called for

improvements in existing government programs to help displaced workers with re-training

and re-tooling, check-lists that would educate Australian companies on the cost-benefit

analysis of offshoring so that they would not rush headlong into it, and changes in industrial

policy to enhance Australian R&D. The sitting Howard government was pleased with the

report and outlined its own policy initiatives, which included more government support for

displaced workers, an effort to increase foreign direct investment in Australia’s IT industry,

and various improvements in teacher training, educational programs, and educational

assessment.

New Australian government data appeared this year, showing that many of the temporary

visas for skilled workers are held by Indians, and many of these visa holders are doing

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programming work. These numbers concerned the Australian Computer Society, and they

have taken harder-line positions on both the skilled temporary visa program (known as

“457” visas) and on a permanent residence visa program, known as the General Skilled

Migration Program. While still endorsing the basic immigration policy of the Australian

government, ACS has called for adjustments in the 457 system to make it fairer. It has also

called for the permanent immigration program (General Skilled Migration Program) to be

substantially reduced until the market can absorb ICT graduates from Australian

universities, Australian computer science enrolments begin to increase, and unemployment

levels for computer workers fall to the level of other professions in Australia.

Sweden provides an example of the policy stance of a Western European country that

engages in offshoring. The Swedish economy and welfare has benefited greatly from a long

tradition of free trade, starting in the late 19th century. The policy includes agreements

between employer and worker associations on the basic principles for wage setting and job

assurance and a commitment to overall Swedish industrial competitiveness in knowledgeintensive

and high-wage industries. This industrial policy caused Sweden to create one of

the biggest high-technological industries in the world; and it has among the highest rates of

investments in R&D and outputs in terms of scientific publications and patenting. Sweden

has also become one of the most internationalized economies in the world, having a high

dependence on foreign trade for its Gross Domestic Product. Part of its industrial

rationalization is through offshoring to countries with lower production costs.

On several occasions, specific industrial policy measures have been taken by the Swedish

government to support industries with low and decreasing international competitiveness. In

the 1970s, considerable industrial support was given to the steel, clothing, and marine

industries when they faced large-scale failures, but the measures turned out to be futile. As

a consequence, Swedish policy has to a large extent returned to the basic policy principles

of free trade, so in the current globalization trends Swedish policy is almost completely free

from protectionist and direct job-protection arguments. There have, however, been a

number of initiatives to improve Swedish competitiveness and counteract the negative

impact of offshoring. They are all related to a new national innovation strategy advanced in

the spring of 2004, which has three fundamental points: technological development and

R&D as the key to Swedish competitiveness, investments in large-scale public-private

partnerships to achieve centers of excellence in R&D for specifically targeted industries, and

reorganization and increased funding for R&D startups and growth of small and mediumsized

research-driven companies. Software is not explicitly mentioned in the plan. In

Sweden, software development and production is primarily embedded in other

manufacturing or service-providing value chains.

Turning now to the developing countries that export software service work, there have

been significant policy issues at the national and state levels that have shaped the climate

for the Indian offshoring industry. These include regulatory policy as it affects foreign direct

investment, taxation, building an infrastructure, protecting intellectual policy, data

protection and privacy, and education and training policy.

The regulatory history is the longest and most comprehensive of all Indian policies

affecting offshoring. From the 1950s to the early 1970s, Indian economic policy focused on

identifying ways for domestic companies to replace imports. Policies enacted in the 1970s

that severely limited foreign ownership in companies operating in India drove out some

multinationals, including IBM. Regulation in the 1980s promoted the development of the

hardware industry and identified software as a promising export business; however, India

had limited success in the 1970s and 1980s in building an indigenous IT industry. India was

forced to liberalize its economy in 1991 in the face of severe cash problems. The new

industrial policy included reduced licensing requirements in most industries, allowed foreign

companies to hold majority interest in Indian companies in many industries, provided for

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automatic approval for hiring foreign technicians and foreign testing of technologies

developed in India, and reduced restrictions on the ways in which mergers and acquisitions

could take place.

Tax policy also had a shaping effect on the Indian software industry. In 1981, the Indian

tax code was revised to establish tax-free zones on profits and gains for manufacturers,

including software manufacturing. In 1993, the law broadened the tax-free zones to include

various science and technology parks. The law was again broadened in 2005 to give tax

breaks to software firms outside these parks.

Infrastructure policy also shaped India’s software industry. Laws intended to build a

favorable infrastructure and reduce labor regulations and other bureaucracy for the software

industry were enacted primarily by individual state governments, mostly in the southern

part of India. The one infrastructure issue subject to federal governance was

telecommunications policy. Beginning in 1991, the telecommunications sector experienced a

series of deregulations that continued until recently. Deregulation enabled the Indian

software industry to have access to a completely modern telecommunications system with a

capacity and cost that enabled the offshoring service companies to be internationally

competitive.

China provides an interesting contrast to India. China is a policy-driven society, and one

sees much more significant intervention of the state in the economic development of the

software industry in China than in India. The national software strategy in India has been

focused on the export service market, whereas the Chinese are interested in capturing their

domestic software product and service markets as well as participating in the export

market.

Until the 1980s there were mainly local rather than national companies in China. Much of

the capital available to businesses was tied in one way or another to the state, and many of

the decisions on capital allocation were made at the local level. Since then, internal trade

barriers have been dropped, enabling companies to build scale and move into neighboring

markets. In recent years, the national government has promoted economic reform through

competition among provinces and growth for individual companies by access to capital

through the national stock market. Consolidation and focus on the international market has

not yet occurred in the Chinese software industry. As of 2002, there were over 6,000

software firms in China; only 19 of them had sales exceeding $120 million.

Chinese policy towards forming technological capabilities has changed over time. From

1978 to 1985, the focus was on central planning and state control. In the period from 1985

to 1991, the focus was on enhancing the innovation system through greater state support

for both public and private R&D. Since 1992, the focus has been on enabling marketoriented

reforms to improve the quality of research and the skills of the workforce, and to

broaden the focus on development beyond the defense and heavy technology industries.

The government has taken a strong hand is the development of trained personnel for the

software industry. This included not only new educational programs, as described above,

but also concentration of highly skilled software talent in certain geographic areas, by

having the government facilitate transfers of skilled software personnel to the chosen

places, including providing accommodation for their spouses and children. The Chinese

government has also provided incentives for overseas Chinese software workers, especially

managers, to return home through such incentives as cash payments, cars, houses, and

promotions.

The Chinese government supports R&D in universities, research institutes, and to some

extent industry. The best known of these initiatives is the Ministry of Science and

Technology’s High Technology R&D Program, known more commonly as the “863 program”,

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which has provided more than a billion dollars of government funding for basic research

since 1986. Other programs to provide research support include the Development Fund on

Electronic Information Industry, an R&D Fund on Industrial Technology, and a Technological

Innovation Fund. Although the government has continued to support important state

research institutes, such as the institutes of the Chinese Academy of Sciences, there has

been an effort to make them less dependent on the state and encourage them to reach out

to obtain external funding sources.

The government has also taken steps to improve the competitive business environment.

China does not have a long history of controlling anti-competitive behavior in a

technological sphere, and it has thus had to pass a series of acts that protect a competitive

environment, making illegal certain kinds of behavior such as impugning another company’s

reputation, bribing, threatening, and dumping. There have been targeted tax reductions to

companies that meet certain sales and export figures. Exporting firms have been given

favorable terms on bank loans, export insurance, and taxes and duties.

China has one of the world’s worst software piracy problems. The Chinese government

has taken a series of steps to try to curb piracy. In addition to the general copyright law,

China has passed several laws targeted at fighting organized crime that is manufacturing

and distributed copies of pirated software. Government organizations are coordinating antipiracy

campaigns, and are being encouraged to be model citizens themselves by using no

pirated software. A registry system has been established, under which owners who register

their copyrighted software are given extra protections under the law. However, software

piracy remains a big issue.

Politics is one of the ways (together with education, consumer boycotts, and labor action)

that nations can respond to offshoring. The general movement has been to avoid

protectionist legislation. Australia and Sweden have completely espoused free trade even

though they risk some level of unemployment for their IT workers. In recent years, India

has moved away from its protectionist and isolationist politics of the 1960s and 1970s. The

United States has had a number of protectionist actions suggested, but most of these

efforts have not been enacted into law, and today there are calls for policies to enhance its

competitiveness rather than to protect its jobs by legal and economic barriers. China is the

most protectionist of the countries studied here.

All of these countries understand that they have to make their national laws conform to

some degree with global practices if they want to be players in the global marketplace. Thus

China, for example, has been willing to revalue its currency despite the short-term gain

from keeping it artificially low; India has eased many of its trade barriers; the United States

has entered into numerous international trade agreements; and Sweden has conformed to

international monetary policies.

All of the countries studied here recognize that there are certain risks of sending software

work across national boundaries. These include questions of intellectual property, privacy,

and data security. Europe has taken the lead in strong privacy policy, and India has seen

the economic value in meeting European and US standards on privacy. China is not so far

advanced in managing these risk issues as India is, but there is every reason to believe it

will have to do so if it wishes to continue to attract international business. China is

struggling with balancing openness of information with political control, and so far it leans in

the direction of control rather than individual rights.

For the developed countries that send work offshore, a common political approach is to

build new jobs and prosperity through policies that increase innovation. Sweden is

increasing government support for research and development, and there are calls for this to

be done in the United States. The two countries differ on parts of the innovation platform,

however. Sweden currently has an abundance of highly educated workers, so it is not

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interested in ramping up its educational system. The United States is facing declines in

foreign scientists studying and working there, as well as declining numbers of American

students studying technical disciplines; so an integral part of the innovation platform for the

United States is to improve the education system and attract foreign workers and students

(to the degree this is compatible with national security policies).

India and China have a number of similar policies for developing their offshoring

industries. Both are interested in ramping up their educational systems to supply an

adequate number of skilled workers for their IT companies. Both are concerned about

having adequate infrastructures (power, transportation systems, telecommunications) to

provide good service to their IT companies. Both have adopted a series of policies intended

to attract foreign investment. China has implemented policies to try to produce a reverse

Diaspora, so that native-born scientists who have been working primarily in the United

States and Europe return home to be part of the senior technical and business leadership in

their IT industries; India has achieved this same effect without explicit national policies.

India has more experience in developing policies to support the export software market

than China, but China is advancing rapidly and has a more centralized government-planning

model in place.

Page 44 W. Aspray and O. Berry took a leadership position in the writing of Chapter 1.

Authors: Alok Aggarwal, William Aspray*, Orna Berry*, Stefanie Ann Lenway, Valerie

Taylor.

Chapter 1: Offshoring: The Big Picture

Offshoring is nothing less than a revolution in the tradability of services.” (World

Investment Report 2004, p. 148)

1. 1 Introduction

In the United States today, there are two views about the offshoring of IT and IT-enabled

services. Some people, such as the television business commentator Lou Dobbs, see a

crisis in our midst. More than a million blue-collar manufacturing jobs in the United States

were lost in the last ten years, mainly to low-wage Asian nations. The solace in all this for

American policymakers had been that another kind of job – the high-paying, white-collar

jobs in the computer and other knowledge industries that had long been dominated by the

United States – seemed immune to competition from low-wage countries. But then the

pattern of job loss began to be repeated in the white-collar labor force as the software and

IT-enabled service sectors moved jobs to Malaysia, the Philippines, China, and especially

India. Dobbs and others called for protectionist measures to stop the hemorrhaging of

high-paying jobs from the US economy. They believed that offshoring was not only going to

do short-term harm to those who lost their jobs, but also long-term damage to the

individuals and communities losing these jobs.

Others disagreed, pointing out that when this work is sent offshore, although domestic

labor may lose in the short term, there are many winners in the high-wage country:

consumers through lower prices; companies through higher productivity, more competitive

pricing, and shorter time to market; shareholders through higher corporate earnings;

company executives through higher compensation packages; and perhaps a select group of

other employees whose jobs change to include more interesting tasks associated with

innovation and exclude much of the drudgery of mundane tasks. Many of the supporters of

offshoring believe that the individuals who lose jobs will be able to find other good jobs,

especially if they are given a safety net from the state consisting of temporary benefits and

retraining, and that the total number of jobs may actually increase over time through higher

productivity and greater competitiveness of the companies that send work to low-wage

countries.

This difference of opinion in the public debates over offshoring is also found among

professional economists. Economists are generally regarded as being in favor of free trade.

For example, one economist who has looked closely at the issue of offshoring is Catherine

Mann of the Institute for International Economics in Washington, DC. She argues that free

trade will eventually lead to greater prosperity for the nation. She points to the case of

computer hardware manufacturing where many manufacturing jobs shifted from the United

States to East Asia in the 1990s as having been highly beneficial to the American economy.

Western innovation, coupled with global sourcing, led to price reductions in products. This

led in turn to more IT investment in the Western nations, higher Western productivity

growth, and ultimately enhanced growth in gross domestic product. Mann believes the

offshoring of computer hardware manufacturing was one of the reasons for the robust

economy in the 1990s in the United States and argues that the long-term national economic

benefits from outsourcing software and services are likely to be even greater than the

benefits from outsourcing hardware manufacturing. On the other hand, both Paul

Samuelson of MIT and Ralph Gomory of the Sloan Foundation, working with William Baumol

Page 45

of Princeton University and NYU, have done analyses that show that high-wage countries

can lose through trade under certain circumstances. (Mann’s argument is discussed later in

this chapter, Gomory and Baumol’s in Chapter 2.)

Looking at this same issue from the perspective of a low-wage country such as India, you

can also see two perspectives. Offshoring work is the top growth area in the Indian

economy, and it is the driver of India’s international trade. Hundreds of thousands of new

jobs are being created, and even entry-level positions in this field pay much more than the

average wage. IT is seen as the way for India to leap from being a third-world economy in

the 20th century to a world leader in the 21st century. However, this IT workforce still

represents only a tiny fraction of the Indian population, and there is a backlash to all of this

change in a country with rich cultural traditions. The traditional family structure is

threatened as young people move to the high tech centers for work, have large disposal

incomes, and otherwise follow work practices that do not fit with traditional culture. This

economic growth has brought congestion, unbridled growth, and severe wage differentials

to cities such as Bangalore. The benefits of offshoring are unevenly distributed with little

benefit for the majority of the people in China or India who are rural, poor, uneducated, and

without English language skills. Some critics complain that government funds spent on

attracting and building the infrastructure for IT companies could be better spent on helping

poor and rural populations with clean drinking water, better primary education, and other

basic infrastructure.

Which of these pictures is correct? Is offshoring leading to long-term deterioration of

Western living standards or is it the means to greater productivity and prosperity in the

West? Is it the economic savior for low-wage countries such as India and China or is it the

death knell for another traditional way of life? This chapter will introduce the subject of

offshoring of software and services and provide a framework for understanding it and

related issues from the perspective of both high-wage and low-wage nations. The following

questions are addressed in this chapter; many of them will receive more detailed attention

in later chapters.

What do we mean by outsourcing, offshoring, and globalization of software?

How did offshoring come about?

How much work is offshored?

Which countries send work offshore and which countries do most of this work?

What types of work are sent off shore?

Why are firms interested in sending work offshore?

What are the technical, business, and other drivers and enablers of offshoring?

Why might a firm, a profession, or a nation not want to offshore work?

Is IT still a good career choice for people working in countries that ship IT jobs

overseas?

1.2 What Do We Mean By Outsourcing, Offshoring, and Globalization

of Software?

It is important to be careful about the terminology used in this study. Outsourcing means

that a firm sends work to another organization to be done. Most outsourcing done by US

firms, for example, is work sent out to other US firms. The client company might have

parts made for them or have another company handle the cleaning of their office premises,

for example. Offshore refers to where the work is done. It is a term that applies best to the

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United States because, even though the United States does outsource work to Canada and

Mexico, most of its work is sent over the seas, largely to India, but also to China, Malaysia,

the Philippines, and many other places. Germany, for example, sends work across its

borders, especially to Eastern Europe, but there is no water – no shore – to cross.

Some of the work that is offshored is sent to entrepreneurial firms established in lowwage

countries. Thus a UK firm that sends work to an entrepreneurial firm in India, such as

Infosys or Wipro, would be sending the work outside their own company.

At other times, multinationals headquartered in high-wage countries operate subsidiaries

in the low-wage countries to work on products and services for their world market. The

multinational might do this by contracting for all the services offered by an entrepreneurial

firm located in the low-wage country, in which case the entrepreneurial firm is sometimes

said to be a captive of the multinational, and the multinational holds great power over the

entrepreneurial firm. The multinational might instead buy an entrepreneurial firm in a lowwage

country outright, or it might create its own subsidiary there. These subsidiary firms,

whatever their organization, represent an increasingly large share of the offshoring of

software services.

Multinationals sometimes open facilities in low-wage countries in order to better serve the

local market especially since the Indian and Chinese markets are expanding so rapidly, but

that situation is not the primary interest of this study. We are more interested in

multinationals that open operations in low-wage countries to serve the world market.

Offshoring is part of a larger trend toward the globalization of software under which

software products and software services are created throughout the world and sold

throughout the world. The aspect of globalization that involves moving work from highwage

to low-wage countries is the most important aspect of globalization for this report but,

over the coming years, other aspects of globalization are likely to become important to the

professional, business, and policy communities.

More precisely, we should differentiate between captive offshoring and outsourced

offshoring or offshore outsourcing as it is often called. For compactness of language, we will

often use the term offshoring in this report without consideration for whether the work is

done by a captive or entrepreneurial firm. Where it matters, we are careful about the

distinction.

1.3 How Did Offshoring Come About?

In order to understand offshoring, it is worthwhile to place it in the historical context of

globalization and multinational corporations. The import of raw goods and agricultural

products from less developed nations and the export of manufactured goods by

industrialized nations goes back centuries to a time when transportation across long

distances became feasible. Over time, some countries placed tariffs and other protective

barriers on international trade to protect their markets or industries. The first period of

intensive globalization came in the nineteenth century when laissez faire economic theory

drove nations to reduce or remove tariffs that limited the movement of goods. Globalization

was also driven by the adoption of the gold standard by many countries in the second half

of the nineteenth century. Gold stabilized the value of money and greatly enhanced trade

across national borders. Globalization led to the concentration of industrialization in the

industrialized countries at the expense of their agricultural bases, specialization in the

manufactured products they exported, growth in population, and demand for greater import

of agricultural products from agriculturally oriented countries. Globalization led to a

substantial increase in wealth for the industrialized countries.

Page 47

This period of globalization ended with the onset of the First World War, and then an era

of protectionism ensued between the two world wars. The second wave of globalization,

which continues today, began near the end of the Second World War with a meeting in

Bretton Woods, New Hampshire in 1944 that led to the formation of The World Bank, The

International Monetary Fund, and the reestablishment of the gold standard. The World

Bank, whose original mission was the financial reconstruction of nations destroyed by the

Second World War, broadened its mission to include reducing poverty through the funding

of state governments to improve their educational, agricultural, and industrial systems. The

International Monetary Fund was formed to oversee the global financial system. This it has

achieved by making the international monetary system more stable and by helping out

countries with monetary problems by supplying them with financial and technical assistance.

The period since the Second World War has been characterized by a series of international

agreements to promote free trade. This period began with the General Agreement on

Tariffs and Trade (GATT). Twenty-three countries participated in GATT’s first round of talks

in Geneva in 1948, but by the Uruguay Round of talks in 1993, the number of countries

participating had increased to 123. The Uruguay Round of talks led to the formation of the

World Trade Organization (WTO) as a successor to GATT. Under the WTO, there have been

a number of different approaches to enhancing global free trade: reduction of tariffs, export

subsidies, and other trade restrictions; formation of free-trade zones; reductions of

restrictions on capital; and increased agreement among national intellectual property laws.

Country membership has grown from 26 in 1993 to 148 today. The net effect of all this is

to have many more countries participating in international trade and to provide conditions

that enable this trade to occur more easily.

Multinational companies, which are simply companies operating in multiple countries,

have played an important role in the globalization of trade. The first multinational was The

Dutch East Indies Company, formed in 1602. The rise of big business in the second half of

the nineteenth century, with its concomitant separation of ownership from management,

created many new multinational companies. Some of these nineteenth-century

multinationals were technology companies such as I.G. Farben, which started its chemical

business in Germany, and General Electric, which started its electric power business in the

United States. Within a few years of their founding, both of these companies were operating

in many different countries around the world.

The computer industry attracted firms from the business machines, electronics, and

defense industries but also included important entrepreneurial start-ups. A number of

companies from the computer industries became important multinationals. These include

General Electric (formed in 1895 and entered the computer industry in the 1950s), IBM

(consolidated in the tabulating business in 1911), Hewlett Packard (formed in 1939 as an

instrument maker and entered the computing industry in the 1960s), EDS (formed in 1962

to serve large users of computers), Microsoft (formed in 1975 to provide products in the

microcomputer software industry), and Dell (formed in 1984 to provide microcomputer

hardware). It is notable but not surprising that these companies all had their origins in the

United States. The United States has dominated the computer industry throughout its

history. In its hey-day, IBM alone held about 70% of the world market for mainframe

computers, for example. The United States also had the market lead in the electronics

industry (mainly because of its dominance of the radio and television industries and its later

need for components for the computer industry) and the semiconductor industry, which

grew as a spin-off from the invention of the transistor at the regulated US monopoly AT&T

and was closely coupled in its history with the computer hardware industry.

US dominance in the computer, electronics, and semiconductor industries continued into

the 1970s, but then some changes began to occur. Perhaps the most public story was the

emergence of Asia as a leader in the manufacture of electronics and semiconductor devices.

Page 48

In the 1970s and early 1980s, major US electronics products firms began to set up affiliates

in Hong Kong, Singapore, and Scotland to use high-quality workers (with wages lower than

US workers) to do labor-intensive assembly such as assembling circuit boards or assembling

price-sensitive products such as computer peripherals or telephones. At first, the

components were built in the United States and shipped to these assembly plants but over

time the assemblers began purchasing components from local sources. Eventually, their skill

levels increased and they began to provide turnkey services. One specific example is disk

drive manufacture which began to migrate from the United States to Asia in the 1980s;

today, very little of this manufacturing takes place in the United States.

A similar story occurred in the semiconductor industry. Beginning in the early 1970s,

American (and later European) semiconductor companies such as IBM, Philips, AT&T, and

Hewlett Packard began to move labor-intensive chip assembly to low-wage countries in East

Asia, including Singapore, Hong Kong, Malaysia, and Thailand. These chips were then

shipped back to the American or European electronics firms for assembly into final products.

During the 1970s, the American semiconductor firms kept semiconductor wafer fabrication,

circuit board assembly, and product-level assembly in the United States. But both

computer and electronics firms opened or expanded plants in Scotland and Wales to do

circuit board and product assembly for the European market in the 1980s. Scotland and

Wales were selected for their educated workers, an English-speaking workforce, and

government incentives to attract foreign direct investment. It also helped that wages were

lower there than in the United States. More recently formed American companies such as

Sun Microsystems, Silicon Graphics, and Cisco never vertically integrated their operations

but instead always used contract manufacturers such as Solectron and Celestrica and chip

fabricators such as Taiwan Semiconductor. These firms were located in the United States,

East Asia, and Scotland.

In the 1980s in East Asia, Singapore’s labor rates became too high and its companies

began to offshore the most labor-intensive work to Malaysia and Indonesia which had lower

wage rates. A similar phenomenon occurred in Hong Kong which offshored its laborintensive

work to China. Singapore and Hong Kong retained the work on circuit board

assembly that could be automated. They also began to add backward integration services

such as component and circuit design, circuit board layout and reconfiguration for better

manufacturing, and forward integration services such as testing, final product assembly,

packaging, shipping, and repair. With a few exceptions, the East Asian companies providing

these value-added services chose not to produce products that competed directly with their

American and European customers. By the end of the 1980s, East Asia had the capacity to

provide circuit boards and electronics products to the entire world. At the same time, the

United States retained and grew its business for higher-value, lower-volume electronics

products such as large computers and communications switching equipment. This work was

often done under contract to specialized contract manufacturers, such as SCI and Solectron,

that were housed in the United States rather than by the large brand-name electronics

product companies themselves.

As more and more of this manufacturing work was done in other countries, middle-class

jobs were lost in the United States. It is hard to count the exact number of manufacturing

jobs created outside the United States to serve the US market or the needs of US-based

multinationals, but the number is probably in the range of a million jobs over the past

decade. The labor force in the US Midwestern industrial states was especially hard hit.

While this caused a public outcry and led politicians to suggest protectionist actions as

mentioned earlier, some economists see a silver lining in these developments. For example,

Mann argues that a combination of technological innovation in the United States and the

increase of global sourcing and markets for hardware (IT, semiconductors, and electronic

components and products) led to price declines. These price declines led to greater

Page 49

investment in IT in the United States. This, in turn, caused increasing transformation of the

American workplace and an increase in the development of new products either

incorporating IT or using IT in its development or manufacture. These developments, she

calculates, caused half of the productivity growth in the United States during the 1990s and

translated into increased wealth for the United States on the order of $250 billion in the

period 1995 to 2000. Mann assumes that there can and will be a similar pattern of growth

for the software industry but that the scale might be even greater for software than

hardware.

While there has been angst in America over the number of good middle-class

manufacturing jobs lost to Asia, there has also been a widespread belief that good jobs in

the software industry would always remain in the United States. However, in the late 1990s

and even more so in the past several years, there is a dawning recognition and fear that

these high-paying software and service jobs will be moved out of the United States as well.

Similar concerns are now beginning to be expressed in Western Europe.

A number of IT-enabled services are being offshored today. They range widely and

include, for example, reading X-ray images of patients, identifying risk for insurance

companies, and processing financial data, as well as testing, building, and maintaining

software for customers. Software was the first service sector to be offshored to a significant

degree. This is perhaps because it was easy to transport the work data and work products

using simple communications equipment (a telephone and a modem) and because there

was a significant wage difference for programmers between the United States (or Western

Europe) and India (or China). During the late 1990s, software offshoring seems often to

have been driven by labor shortages in the United States, especially associated with fixing

the Y2K problem and creating new Internet products and services during the dot-com boom.

When the dot-com bubble burst, offshoring continued – with cost as a major driver – and

began to represent jobs transferred overseas rather than jobs supplementing an insufficient

US labor market. The practice of offshoring became a political issue in the United States

only after the recovery from the 2001 recession was historically weak in its creation of jobs.

European concern about offshoring lagged behind US concern presumably because the

United States began to offshore first and has always offshored to a greater extent than

Europe.

Firms have outsourced work for centuries, sometimes even to companies that are outside

their national borders. The first offshoring in the software and IT services sector began in

the early 1980s: US firms sent some credit card processing to the Caribbean and

established call centers there. Software centers provided software services to the PC

manufacturers in Malaysia at about the same time. However, there was no substantial

software offshoring industry until the 1990s. India, Singapore, Ireland, Israel, and Hungary

were all early entrants in the offshoring business. Despite some differences in focus from

country to country, described in a later section of this chapter, all of these countries

benefited from first-mover advantages. Every several years, as a new application area

became hot, the offshoring firms in these countries would turn their attention to this

application, moving from business downsizing/reengineering, to Enterprise Resource

Planning, to Y2K, to Euro conversion, and so on. These offshoring firms coupled this

strategy with an effort to move up the value chain through industry sector specialization in

order to deepen their expertise and build trusted relations with clients who would eventually

turn over progressively higher level and more profitable tasks for them to do.

The story of how offshoring began in the major vendor countries, such as India and

China, is told in Chapter 3. These case studies indicate that offshoring has meant several

different things. In India, for example, it began with body-shopping, the process of sending

trained programmers to work for a few months in another country on the client firm’s

premises. This was followed by a blended strategy in which some of the work was done on

Page 50

the client’s site and some at the vendor’s site in India. Then call centers opened. In the

past five years, facilities began to be established to carry out IT-enabled business processes

such as accounting. More recently, Indian firms have begun to move up the value chain to

do IT-enabled knowledge processing such as reading X-rays, conducting patent analyses,

and carrying out IT research and advanced development. The players in this story were at

first Indian entrepreneurial firms. But later, multinational firms came to play an important

role, sometimes through an Indian firm that did contract work for the multinational

company, but also through a firm purchased outright or started up by the multinational

company.

The globalization of the marketplace is helping to drive offshoring. The Indian and Chinese

governments, for example, have taken many steps to ready themselves to participate in the

international software market. Software is seen as attractive to low-wage countries as a

way to bolster their economies more quickly than the boot-strapping strategies tried in the

past by developing nations. In fact, about one-quarter of all offshored shared-service

centers for European clients involve interactions with the development agencies of the

vendor’s country (World Investment Report 2004). These countries have used tax breaks,

marketing subsidies, grants, loans, reduced bureaucracy, and other techniques to attract

foreign business and foreign capital. China passed the United States in 2002 as the most

preferred location for foreign direct investment. Trade policy has been liberalized in these

countries, for example, by reducing or eliminating export taxes and licensing (see Chapter 8

for details). These governments have enacted policies to strengthen the public and private

education and training sectors (see Chapter 7). Subsidies have been provided for research

and development activities in their countries, especially for development work that is likely

to have a near-to-midterm payoff in new products or services. Governments are trying

harder to protect intellectual property which has been an especially serious concern to

Western businesses about China (see Chapter 6). The Indian central and state governments

have worked to improve basic infrastructures such as telecommunications, electric power,

transportation (both roads and airports), buildings and technology parks, and other

amenities such as international-class hotels, but the infrastructure started in a poor state

and the government is not efficient in these efforts. Table 1 describes the state of

infrastructure in Bangalore, India’s leading offshoring location.

Table 1-1: Bangalore’s Infrastructure for Conducting Offshoring Work

Electric power is unreliable, so most companies have backup generators.

Roads are congested and in ill repair (an hour to travel the 12 miles from center

city to the outskirts where the outsourcing companies have their campuses in Electronics

City and Whitefield).

Work has not yet begun on a new international airport.

There is a shortage of rooms in international quality hotels.

No mass transit exists (talking of elevated railway) so most companies hire their own

buses to bring employees back and forth to work.

Telecommunications infrastructure is improving rapidly (cell phones, satellite

transmission, transoceanic fiber optic cable).

Source: Fannin (2004)

Page 51

1.4 How Much Work Is Offshored?

The answer to this question is that nobody has very good data on the amount of

offshoring worldwide, whether one measures the number of jobs lost or created through

offshoring, the number or percentage of companies offshoring work, the number of

companies providing IT software services for export, or the monetary value of this work.

Chapter 2 provides a detailed analysis of the problems with the data. It also provides a

sample of the statistics about the extent and impact of offshoring in the United States,

Europe (with separate breakouts for the United Kingdom and Germany), and India. Adding

these numbers up gives some sense of the global situation. In Table 2, we provide a sample

of the worldwide statistics as already totaled up by others. One can see from the McKinsey

(2005) statistics that the actual number of jobs offshored is still a small fraction (less than

15%) of the number that could be offshored. Other statistics in the table make it clear that

one type of offshoring –business process services – is growing very rapidly, and that there

is room for considerable growth since only 30 percent of the largest 1000 corporations are

currently offshoring any work of this type. It is also clear that India is the major provider of

these services. We do not have good numbers for the amount of software service work

(software maintenance, testing, programming) being done independent of work for call

centers or business process outsourcing. Nor can we tell exactly how much of the

offshoring work is being done by independent firms and how much by subsidiaries of

multinationals, although it is clear that the latter are a large part of the total. The numbers

do, however, give a general sense of the scale of offshoring activity worldwide. Additional

information about the size of the Indian and Chinese shares of the world offshoring and

software markets is given in Chapter 3.

Table 1-2: The Extent of Offshoring Worldwide

Source Data Reported Statistic

McKinsey & Co. (2005) Amount of onshore

outsourcing worldwide as of

2001

$227 billion

Amount of offshore

outsourcing worldwide as of

2001

$10 billion

Amount of captive offshoring

worldwide as of 2001

$22 billion

Number of IT services jobs

globally that could be done

anywhere in the world as of

2003

2.8 million

Number of service jobs

worldwide that could be

done anywhere in the world

160 million

Number of actual IT service

jobs in offshore operations

in low-wage countries as of

2003

371,000

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Evalueserve (2004) IT offshore revenue

worldwide, April 2003-March

2004

$17 billion (almost half from

India, almost one-quarter

from Ireland; includes IT

products shipped from

Ireland)

UN Conference on Trade and

Development (2004) (as

quoted on TurkishPress.com)

Percentage of world’s

largest 1000 companies

offshoring business process

outsourcing

30

Value growth in offshore

business process

outsourcing worldwide

(projected)

$1.3 billion in 2002 to $24

billion in 2007

Scholl (2003) (as quoted in

World Investment Report

2004)

Market value for offshoring

of IT services (not including

captive production for

multinationals)

$1.3 billion

McKinsey & Co. (2003) (as

quoted in World Investment

Report 2004)

Market value for offshoring

of IT services, including

captive production for

multinationals

$32 billion

1.5 Which Countries Send Work Offshore and Which Countries Do

Most of This Work?

Countries that send software and IT-enabled service work offshore are primarily highwage

countries that have advanced service industries. These are also the countries that

have the largest amount of IT work. According to Datamonitor (May 2005), the global data

processing and outsourced market had a value of $246 billion in 2004 with North America

accounting for 43.6%, Europe 29.4%, Asia-Pacific for 17.8%, and the rest of the world

9.1%. The country that started the offshoring trend and that sends the most work offshore

is the United States. The United Kingdom, Germany, France, and other Western European

countries come next. Although Japan has an advanced economy, it does not offshore as

much work as the United States or the Western European countries. In an interesting turn

of events, Indian offshore companies have begun to open facilities in China (where wage

rates are lower than in India and a huge local market is opening) and Eastern Europe (to

take advantage of proximity to the Western European market –nearsourcing). The extent of

this phenomenon is limited and recent, and it is not clear whether it is a strategy for Indian

firms based primarily on obtaining more contracts or on taking advantage of lower-wage

labor.

Which countries do the offshoring work is a more interesting story. There are quite a few

countries that have tried to develop this business, and these countries vary considerably in

their skill sets, labor costs, cultural fit with the countries seeking to have work done, levels

of technical and business expertise, and type of work that they offshore. The four countries

that have the most established offshoring industries (accounting for 71% of the market in

2001) in order of market share are Ireland, India, Canada, and Israel (McKinsey & Co. 2003

as quoted in World Investment Report 2004). The public stories make one think that

offshoring work is all done in low-wage countries such as India and China. In fact, the

Page 53

majority of offshoring services have historically been provided by developed nations, and

Ireland still leads with a 25% share. However, as Arora and Gambardelli (2005) point out,

the value added in Indian offshoring is higher than in Ireland because so much of the Irish

work involves localizing US software products for the European market. Moreover, the

growth rate of the national software export industry is much higher in India than in Ireland

so the relative position is changing rapidly. Canada and Ireland do have lower wages than

the United States, perhaps 10 to 20 percent lower, but there are not the extreme wage

differentials as there are between the United States and India or China. So this is not yet a

north-south or developed/undeveloped nation issue although the trend is in that direction

(World Investment Report 2004).

An assessment by the consulting firm A.T. Kearney of the most desirable future locations

for offshore work placed India at the top of the list, followed by China, Malaysia, the Czech

Republic, and Singapore (A.T. Kearney 2004 as quoted in the World Investment Report

2004). The expected rapid growth in offshoring activity occurring in low-wage countries will

make the public perception of who does offshore work progressively more accurate. The

Kearney report listed Brazil as the leading offshore source in South America; South Africa in

Africa; Hungary, Poland and Romania in Central and Eastern Europe; and Canada and New

Zealand among developed nations. Ireland, Portugal, Spain, and the United Kingdom were

listed as the preferred destinations for offshore work within Western Europe.

Countries doing offshore work fall into four categories as shown in Table 3. First are

those countries that take advantage of their large capacity of highly trained/educated

workers and low-cost wage scale. One example is China which has established businesses

providing offshore work on embedded software and IT-enabled financial services. Another

example is Malaysia which is building up business at the lower end of the offshoring market

in call centers and IT-enabled back-office business processing services. The principal

example is India which is the fastest growing destination for offshore work and is involved in

almost every aspect of the industry from call centers to business process outsourcing, to

software maintenance and testing, to software research.

The second category consists of countries that have competitive advantage through their

language skills to serve a special part of the market. While it is useful in any kind of

offshoring work for vendor and client to be able to speak the same language, it is essential

that workers in call centers, for example, be able to speak fluently in the language of their

customers. Thus China, which has relatively few people who speak English fluently, is

unlikely to become a major provider of call centers to the United Kingdom or the United

States. The Philippines, Mexico, Costa Rica, Chile, and Morocco have taken advantage of

their bilingual skills in English and Spanish to open up call center businesses serving the

United States. South Africa is the leading offshoring nation in Africa because of its Englishlanguage

skills. Some countries from Francophone Africa (Mauritius, Morocco, Senegal,

Tunisia, and Madagascar) have recently started to provide call center and telemarketing

service to France. India, of course, has been able to build up its call center business in part

because of its English-language skills.

The third category consists of countries that take advantage of their geographic proximity

to a country that offshores work, so-called nearsourcing. The nearsourcing countries not

only are located nearby, making it easier for executives from the client firms to visit the

vendors, but there is often a shared language and culture as well. These countries

generally do not have extremely low wages, but their wages are typically lower than in the

country that is offshoring the work. Canada is a major nearsource destination for the

United States, providing many high-end services. Poland, the Czech Republic, Hungary,

and increasingly the Ukraine, Belarus, Romania, and Latvia are building nearsourcing

businesses to serve Western Europe, especially Germany. In a poll of 500 top European

companies in 2003, the German consulting firm Roland Berger found that 50% of European

Page 54

firms were planning to offshore to other parts of Europe and only 37% were planning to

offshore to Asia (Gumbel 2004). China is trying to establish a nearsource business for

Japan and Korea. (One could call the second category linguistic nearsourcing and this third

category geographical nearsourcing. Doing so suggests that there are other kinds of

affinities between nations that might make them want to do business with one another such

as a common heritage or legal system as exists between the United Kingdom and countries

in its former empire.)

The fourth category consists of countries that have special high-end skills. Like the

nearsourcing countries, the wage rates might not be as low as in India or China, but they

are lower than those in the United States or Western Europe. Israel provides offshoring in

the form of research and development for multinational corporations and niche software

products and services, especially in the security and anti-virus software markets. Ireland’s

offshore business is mainly in the area of packaged software and product development; it

hosts many multinationals who are building software products and providing IT services for

the European market. It also has a number of small Irish-owned companies operating

mainly in niche markets. China is beginning to develop high-end skills in the Linux

operating system, bioinformatics, and anti-virus software. Australia exports high-end, ITenabled

financial services. India is beginning to develop research and development

laboratories for various European and American-based multinational corporations. Also, one

should not neglect the United States which exports the highest amount of IT products and

services of any nation, mostly to Europe, and mostly in the form of packaged software and

consulting services.

Table 1-3: Nations that Do Offshoring Work

Strategy Principal Examples Others

Cost and Capacity China

India

Malaysia

Language Skills Philippines

Mexico

Costa Rica

India

South Africa

Tunisia

Morocco

Senegal

Madagascar

Mauritius

Nearsourcing Canada

Poland

Czech Republic

Hungary

Slovakia

Ukraine

Belarus

Romania

Latvia

China

Special High-End Skills Israel

Ireland

Australia

United States

China

India

Russia

1.6 What Types of Work Are Sent Offshore?

Various kinds of work involving the use of information technology are being offshored.

Types that are of primary interest in this study include:

programming, software testing, and software maintenance,

Page 55

IT research and development, and

high-end jobs such as software architect, product designer, project manager, IT

consultant, and business strategist (the extent to which these jobs have been

offshored is an open question).

Because the focus of this study is on offshoring of software and services, we are not

primarily interested in the following kinds of IT-related work, even though they are

frequently offshored:

physical product manufacturing – semiconductors, computer components,

computers,

business process outsourcing/IT enabled services/knowledge process outsourcing

(e.g. insurance claims, medical billing, accounting, bookkeeping, medical

transcription, digitization of engineering drawings, desktop publishing, and highend

IT enabled services such as financial analysis for Wall Street and reading of

X-rays), and

call centers and telemarketing.

A detailed list of the various kinds of IT and IT-enabled services that are being offshored

can be found in the World Investment Report 2004 (p. 150). These include various types of

audiovisual and cultural services, business services, computer-related services, higher

education and training services, financial services, health services, Internet-related services,

professional services, and animation. Many of these fall outside the principal focus of this

study. In Table 4, we identify skill levels required for various kinds of IT and IT-enabled

services also taken from the World Investment Report 2004.

Table 1-4: Skills Categorization of Traded IT and IT-Enabled Services

Skill

Level

Definition Examples Requires Comments

low Low entry

barriers in

terms of skills,

scale,

technology

Data entry

Call centers

general formal

education

working

knowledge of

relevant language

basic computer

skills

few economies of scale

little agglomeration

medium Complex

services that

require more

advanced skills

financial and

accounting

services

standardized

programming

work

routine data

analysis

back-office

services such

as ticketing

specialized

training required

(perhaps in

training schools)

may offer economies of

scale

may have agglomeration

effects

Page 56

high Most creative

and skillintensive

work

R&D

Design

services

Architectural

drawings

software

design

Animation

Medical

testing

Technology

systems

design

Advanced skills at

high levels of

specialization,

often with strong

educational

institutions

stringent entry

requirements

involve agglomerated

economies with different

skills, enterprises, and

institutions interacting

with each other to share

work, stimulate

knowledge flows and

allow specialized skills to

be fully utilized

Based on Box IV.2 in World Investment Report 2004

Jobs that are at the greatest risk of being offshored are also often those most at risk of

being automated, in which case labor would be replaced by technology instead of by foreign

labor. For example, although it has not happened to an extensive degree yet, software

automation tools might help to automate low-end software development.

The situation is far from static. We described earlier how India first offered bodyshopping,

then software services, only later IT-enabled services, and most recently research

and development. There has been a similar change in the pattern of offshoring by firms in

high-wage countries. In the 1980s and 1990s, the typical pattern was for an IT manager to

hire an outsourcing firm to carry out some task that was not critical to the mission of the

client firm. It tended to be an application development that was highly structured, required

relatively little interaction and project management from the client, had clear deliverables,

well understood bidding procedures, and transparent risk to both the client and vendor.

Often the vendor was located near the client. More recently, the pattern has changed. The

outsource firm is hired not by the IT manager but by a higher-level executive such as the

CFO, CIO, or perhaps even the CEO. The task is more likely to be mission-critical to the

client. The applications are wide ranging, but they often include tasks that are less well

structured than in previous times; ones that require greater amounts of client contact and

project management and where deliverables, costs, and risk are less clear. The vendor is

as likely to be located in another country as nearby.

But what are the characteristics of work favorable to performance offshore? John Sargent

and Carol Ann Meares of the US Department of Commerce have provided an excellent and

detailed answer to this question that is adapted slightly in Table 5.

1.7 Why Are Firms Interested In Sending Work Offshore?

The public perception is that companies in the United States, Western Europe, and Japan

send work to India, China, and other low-wage countries principally because of the lower

labor cost. There is some truth to this perception. Companies want to maximize their

profits, and, in many cases, the lower cost of qualified labor in these countries is the

principal reason for making the offshoring decision. Sometimes companies begin offshoring

for cost reasons but continue for quality of work reasons. Sometimes something else drives

the initial decision to offshore, for example, the lack of enough qualified workers in the

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United States during the Y2K era. This section shows that the situation is complex. There

are at least nine reasons, low-cost labor among them, why companies send work offshore,

and often more than one reason is in effect in a company’s decision to offshore. Here is a

summary of those reasons. Chapter 4 gives examples of the ways in which particular

companies of various types use offshoring as a strategic tool.

Table 1-5: Characteristics of Work Favorable to Performance Offshore Through

2004

high wage differential with similar occupation/level in destination country

high labor intensity

clearly defined requirements, little nuance

repetitive tasks

rule-based decision-making and problem solving

documented or easily transferred content and process knowledge

discrete, separable; low degree of interaction across different services, applications

low degree of personal interaction with end users, clients

stable applications with minimum of “firefighting”

long projected useful life to amortize offshore set-up costs

low-to-medium business criticality

less time-sensitive, longer transition periods

projects involving simple and standard hardware and software

digital, Internet-enabled

low setup barriers

low-to-medium technical complexity

not-multidisciplinary

projects in business areas in which offshoring is a broadly accepted concept

tightly defined work processes

stable process

Source: Sargent and Meares (2004). Note: as the Indian companies, for example, move up the value chain, the

characteristics of work subject to being offshored may change.

1. Reduced Costs and Increased Margins. In the modern, investor-driven, globalized

marketplace, there has been a compression of resources, both time and money, that

companies, new and old, have with which to make a new business model profitable.

One response to this compression has been to reduce costs. Labor costs are a major

portion of service and other knowledge-intensive businesses so it is natural to want to

reduce these costs. When a new software engineer costs $45,000 annually in the United

States and only $5,000 per year in India, even with many additional overhead costs

associated with offshoring, most firms anticipate substantial savings in sending work to

the Indian software engineer over doing the work in-house in the United States. In this

way, the companies can make their new business start-up funds last longer or increase

their profit margins. While the focus in the public perception is on the low salaries, costs

are also sometimes reduced because the offshore vendor has scale benefits in doing the

work. (Another response to this compression, to address the time issue, is given in point

5.)

2. Access to Skills. The United States has the strongest postsecondary system in the world.

It trains many highly qualified workers from both home and abroad, and it also imports

workers who are educated or trained in other countries. But the United States does not

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have a monopoly on highly talented, educated, and experienced workers. As China,

India, Russia, and Eastern Europe have joined the world market, there is now an excess

of educated workers in certain countries such as India, Ireland, Russia, and some

Eastern European countries at a time when the US math and science educational system

is slowing down its production. In 1999, for example, China graduated three times as

many engineers as the United States. In particular, we are seeing strong pools of talent

outside of the United States in the IT, telecommunications, engineering, and health care

domains.

Thus another reason for companies to send work offshore is the size and quality of the

available labor pool. The applicant pools available to the offshoring companies in the

leading offshoring countries in many cases have been larger and stronger than the

applicant pools available in the United States and Europe. In the late 1990s, many US

firms turned to Indian vendors because they had available programmers with the

knowledge of legacy systems to make Y2K fixes. Similarly, during the dot-com boom in

1999 and 2000, many US firms turned to offshore vendors to find enough people who

knew the Java programming language. There was an abundance of such people in

India, for example, not only because of the large labor pool but also because of the

tendency of the Indian higher education system to react quickly to the marketplace and

teach skills that are in current demand.

To take advantage of this labor pool, many of the best offshoring vendors spend

substantial money on the hiring process, going through a lengthy and rigorous screening

process to identify employees who have a higher average quality than those available

for the client firms to hire directly. NASSCOM, the Indian software and services trade

association, has expressed concern recently about the uneven quality of the Indian

educational system, contending that while there are still large numbers of graduates, not

all of them have the quality education that gives India this competitive edge in offering

this access to skills.

3. Experience. Companies from the United States and Western Europe sometimes choose

to send work offshore because other countries have greater experience in a particular

field than they do. This experience can be of four types:

A. Experience with a particular technology. For example, China already has the largest

number of mobile phones in the world and India may be the second in this regard by

2012; these countries have skipped a level by not putting the infrastructure in

landlines but investing more in the wireless domain. Hence, it makes good business

sense to do R&D on wireless in India, China, and other emerging wireless markets. A

similar situation pertains to Linux which is a part of the Chinese government’s

national technology policy. While India and China are not yet the world leaders in

these fields, they have a growing number of scientists and engineers with knowledge

of these fields, and the overall level of knowledge in the country is growing rapidly.

B. Experience with a particular scientific domain. There are, for example, several

countries that provide offshore services with strong labor pools in the biomedical

disciplines.

C. Experience with particular management issues. For example, several of these

countries have strong experience managing projects that operate multiple shifts per

day.

D. Experience with cultural and marketing issues in emerging countries.

4. Time Shifting. Offshoring enables companies to offer multiple-shift services that may not

have been offered prior to offshoring. For example, US hospitals are using US-trained

Indian physicians to read X-rays in India in time to deliver the results to the US doctors

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the next working day. This move can increase patient service at a reasonable cost.

Offshoring medical services can also provide rural areas with access to affordable

medical services. Some IT companies have several offshore sites, located strategically

by time zone, that enable them to provide round-the-clock services such as help desks

and network monitoring, while requiring none of their workers to have to work the

graveyard shift.

5. Time To Market. Some companies offshore work in order to reduce the time to bring a

product to market. The types of work offshored for this reason include R&D, production,

and other parts of the supply chain. One reason that time to market can be reduced is

that companies can take advantage of time shifting. A design team in the United States

can work regular business hours and then turn the work over to their team in China,

which is just beginning its regular work day, to either continue the design work or do

code checking. Then the Chinese team can turn the work over to their Indian colleagues

for the next shift who work on it and turn it back to the US team to start the process all

over again. Another way to take advantage of offshoring to reduce the time to market is

to divide the work into self-contained tasks that can be worked on in parallel in several

locations. Yet another strategy for achieving faster time to market is to

compartmentalize the work into a set of tasks that require different skill sets and parcel

the work out to the teams around the world that would be most effective or productive

at doing a particular part of the work. With synchronization points, this modularized

work process can be used effectively to create one single larger product developed on a

distributed basis in a timely manner.

6. Market Access. Companies sometimes find it strategically attractive to have a market

presence in countries in which they would like to sell their products. As

Balasubramaniyan, general manager at Wipro Technologies, describes this issue:

“Offshoring also helps a company be closer to its global customers, thereby providing

appropriate offerings to its regional market and ensuring speedier problem resolution.

Developers and support personnel in the relevant geographies have a better

understanding of customers’ needs, regulatory compliances and regional preferences,

and can better implement the product or provide the service.” (Balasubramaniyan and

Guyer 2004).

7. Ability to Send Overflow Work. Many small IT companies, especially those in IT services,

are usually faced with “feast or famine” situations, that is, during any given period of

time, either they do not have enough work or they have too much work. These small

companies cannot afford to keep a very large workforce on their payrolls because they

cannot afford the payroll in lean times, and therefore they have to work with a minimum

workforce. However, this causes problems for the company when it lands a large project

that needs to be completed in a short period of time. These companies can benefit by

sending work to large offshore providers who can supply very capable professionals with

the right domain expertise at the right cost. Larger companies face this same problem.

Companies are unlikely to want to hire extra staff for a project that might only have a

six-month or one-year duration because of the cost of hiring and the morale problems of

having to lay these workers off at the end of the project. The use of offshore workers

enables a company to ramp up and down quickly without these problems.

8. Extending Venture Capital Money. After the dot-com and the telecom busts in 2001,

many startups, especially in the IT, telecom, and biotech areas, have found it difficult to

raise venture capital. Those that have been able to raise such funding – as well as those

who are working on a “shoestring” fund provided by family and friends – are left with

little choice but to make the funding stretch as far as possible. Lower-cost locations such

as Israel and India become very attractive for them, and so it is not surprising that by

March 31, 2005, more than 170 startups already had established their R&D centers in

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India. Often, the venture capital firms themselves are pressuring the companies to use

offshoring to keep costs down.

9. Other Business Reasons. Using offshore workers can have other business advantages.

Given the low cost of labor, a number of the better offshoring vendors have expanded

the ranks of their middle managers who have time to mentor and enhance the skills of

the lower level employees and identify and implement process improvements that make

the work effort more effective. The vendor might have access to tools that are not

available to the client either because they are proprietary or because they would be too

expensive for the client to buy but not too expensive for the vendor who can use them

for many different clients. Clients who are not in the IT business may have more time

to focus on their core business and maximize their overall profits if they offshore their IT

tasks. Some companies have found that because the offshore vendors are eager to

retain their business, there is a stronger focus on continuous business improvements

and customer service than if the work had been done in-house. Public sector

companies, who may be regulated against large cost overruns and have rigid work rules

that make hiring new employees difficult, may find that offshoring provides them with

new flexibilities.

1.8 What Are the Technical, Business, and Other Drivers and

Enablers of Offshoring?

Offshoring has been made possible by a collection of technological, business, work

process, policy, educational, and other changes over the past 15 years. The technological

changes are the ones that are most often mentioned in the discussions about the growth of

offshoring, but they are by no means the only ones.

(1) Telecommunications infrastructure. Since the late 1990s, there has been a dramatic

increase in the telecommunications infrastructure. As part of the dot-com boom, various

telecommunications carriers competed to increase satellite and optical fiber networks to the

point where there was a glut in the market after the dot-com boom ended and prices

plummeted. India now has readily available low-cost, high-bandwidth communication and

access to all the major telecommunications applications such as email, fax,

videoconferencing, and cell phone. Telecommunications capacity between India and the

United States grew from practically nothing in 1999 to 11,000 GBS in 2001. The cost of a

one-minute telephone call from India to the United States dropped more than 80% within

several years after January 2000.

(2) Changes in information technology. A number of changes in information technology

also changed the opportunities for offshoring. Low-cost computing power became readily

available. Software platforms became standardized: IBM and Oracle provided the standard

for database management, SAP for supply chain management, PeopleSoft for human

resource management, and Siebel for customer relations. Offshoring vendors could invest

in the purchase of a small number of standardized software platforms and train their

employees in their use rather than having to deal with possibly hundreds of proprietary

software systems. Workers could learn standardized skills that were then portable.

Training and skill certification became simplified. A similar effect was created by using

commoditized, inexpensive applications software packages. Standardization of data formats

and networking protocols made it easier to move large data sets from client to vendor.

Interoperability standards such as MDA, UML, CWM, CORBA, and OMA were established

during the 1990s, making it easier to modularize software.

(3) Pace of innovation. The technological changes mentioned in (1) and (2) can be

considered enablers. One study (Bartel et al. 2005) discusses technology as a driver of

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offshoring. It found that a high level of IT use in an industry is not a predictor of greater

outsourcing. However, an increase in the pace of information technology change does

increase outsourcing. The explanation is that firms are more willing to gain access to the

latest technology through their outsource vendor than by sinking fixed costs into a

technology that is likely to change with great rapidity. One would describe the dot-com era

as an era of rapid IT change, hence driving companies to outsource.

(4) The downsized corporation. Since the 1970s, businesses in the United States began

to move away from vertical integration of the corporation, shedding activities that were not

regarded as core competencies, through eras of reengineering and downsizing. During the

1980s and 1990s, more and more activities were pared from the list of core competencies

and subject to outsourcing. As IT systems became more standardized, they were seen less

as core activities. And as corporations focused more on core competencies, there was big

growth in outsourcing of functions outside the core.

(5) Other business drivers. There have also been some business drivers of offshoring.

When rival firms began offshoring, many companies felt that they had to offshore in order

to remain competitive. Companies looked for ways to cut expenses to deal with the

economic downturn that began in 2000. Venture capitalists began pushing startups to

incorporate offshoring into their business plan so that the burn rate on start-up funds was

lessened. Several high-profile business leaders, such as Jack Welch from General Electric

and Carly Fiorina from Hewlett Packard, became evangelists for offshoring. As experience

with offshoring mounted, some of the early mistakes were understood and some of the

early problems with bureaucracy and infrastructure were fixed. It became more acceptable

and less risky to offshore; offshoring was no longer restricted to the early adopters such as

Texas Instruments or General Electric. Business leaders began to recognize the value of

reengineering, both in cost savings and improved performance, that was often undertaken

when work was transferred from client to vendor.

(6) Intermediaries. The offshoring business created new specialty occupations and firms.

Some of them did part of their work on the client’s site and offshored the rest; some did all

the work offshore on their own premises. Some served as brokers, placing the client’s work

with one or more of a number of offshore firms. Others served as consultants, helping

companies to make the decision about whether to offshore, what work to offshore, and how

to make contact and close a deal with an appropriate offshoring vendor. These consulting

firms and brokers aggressively marketed the advantages – particularly the labor cost

advantages – of offshoring. The presence of these specialty firms made it possible for

smaller companies to offshore work by helping them with the management of offshored

projects in a cost-efficient manner. Another group of firms emerged to provide support

services to the offshore vendors: transportation services, catering services, access to

specialty knowledge workers, and the like.

(7) Changes to the work process. Changes to the work process have enabled offshoring.

Certain kinds of knowledge work have been digitized and business processes have been

reengineered, making them suitable for offshoring. The value chain has been divided into

separable work processes some of which can be routinized and made subject to offshoring

even when not all aspects of the process are amenable to offshoring. This kind of

fragmentation of labor process is much more easily done with software and services than

with manufacturing. There is also more personal acceptance of having old ways of doing

business transactions replaced by using the Internet or proprietary networks to acquire

services so there is less resistance to service at a distance. All of these reasons add up to

the fact that progressively larger amounts of work can be offshored each year.

(8) Higher education system. In the past, one of the great advantages of the United

States has been its higher education system. However, some of the developing countries

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are using higher education as an effective means to create a skilled workforce, and the

numbers are impressive in comparison to the United States. Model curricula, established by

professional organizations such as the ACM and the IEEE, have been adopted in many

different countries, and the computing machinery needed for classroom instruction is

inexpensive in these days of personal computing.

In India, for example, national policy since the Second World War has placed a surprising

amount of limited resources into developing the post-secondary educational system rather

than in supporting the primary or secondary systems. There are 160 universities and 500

institutes today in India offering computing degrees of one kind or another, and the number

is growing rapidly. This is not yet as large as the number of colleges and universities

awarding computing degrees in the United States where about 200 universities offer ITrelated

doctoral degrees and about 2000 colleges and universities offer four-year degrees.

However, the number of technical degrees awarded in India as opposed to the number of

degree-granting institutions tells another story. India is awarding a much higher

percentage of its degrees in technical fields than the United States is. Each year, India

awards approximately 290,000 engineering degrees which includes 120,000 information

technology degrees, while the United States awards a total of approximately 75,000

computing degrees at the bachelor’s, master’s, and doctoral levels. India has also rapidly

built up a set of institutions for training people for jobs in IT skills training and certification.

To cite just one example, the offshoring firm Wipro has established Wipro University with 70

full-time instructors. It trains 2500 workers per year in areas directly pertinent to Wipro’s

offshoring work.

The United States still holds some significant advantages over India in the higher

educational system. Although India has a much larger population than the United States,

only a small fraction of its population attends college (7% as of 1997). The Indian system

is strongest in IT skills training and undergraduate degrees. University research in India is

very modest, and India produces only 300 master’s degrees and 25 doctorates each year in

the computing disciplines, compared to 10,000 master’s degrees and 800 doctorates in the

United States. For many years, the United States has been considered the place of choice

for advanced degrees for people throughout the world, but this seems to be changing.

Because of visa tightening and attitudes towards the United States in the post-9/11 era, the

number of foreign students applying to graduate school in the United States has

plummeted. The United States also has decreasing numbers of domestic students studying

IT (or science and engineering subjects more generally).

(9) Free-market world economy. The development of a world economy since the Second

World War has provided the opportunity for creating a global software market.

International agreements such as GATT and increasing national participation in international

organizations such as the World Trade Organization, the collapse of communism, and the

liberalization of the economies of India and China have all contributed to making the

software market global and in making India and China major participants in this market.

(10) Immigration. Immigration has played a role in the growth of offshoring. A large

number of Indian and Chinese citizens came to the United States to study and many of

them stayed on to work. In concentrated high-tech regions of the United States, most

notably in Silicon Valley, communities of Indian high-tech entrepreneurs emerged and

bonded with other Indians in the high-tech community, and similarly for the Chinese. In

many cases, these technical entrepreneurs were the ones who started offshoring companies

or who were the go-betweens to ease the difficulties of doing business across so many miles

and such different cultures. US immigration policy, especially the H1-B and L-1 visa

programs, have enabled Indians and other foreigners to gain valuable experience and

contacts in the United States before returning to their home countries. Recently, there has

been a reverse diaspora of engineers, and China and India are both recruiting technical

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workers to return permanently to live and work in their native countries. China has been

providing all-expense-paid trips to China, holding job fairs in Silicon Valley, and recruiting

faculty members online to spend their sabbaticals working in China. India has been

providing salaries, benefits, and stock options that make living in India attractive to Indian

high-tech workers who had been working in the United States.

(11) Other factors. Other factors have also played a role in driving or enabling offshoring.

The fact that English is the language of education and business has helped make India more

attractive to US firms. That India’s accounting and legal systems are compatible with the

British and American systems has also been an attraction. An aging population in the

United States means that the country will need to reach outside its national boundaries for

its workforce of the future. The McKinsey Global Institute projects a US need for 16 million

additional workers from overseas over the coming decades in order to maintain the present

ratio of workers to retirees. Evalueserve predicts a 5.6M worker shortfall by 2010, including

a shortage of 970K IT workers (assuming no work is offshored and not counting

immigrants). This shortage would lead to higher prices, being less competitive, and loss in

Gross Domestic Product. US temporary visa policy (for H1-B and L-1 visas) has been

conducive to building the offshore vendor presence onsite in the United States and in

building networks of people between India and the United States especially in Silicon Valley.

For the offshoring of research, international projects such as the International Space Station

and Human Genome project have built ties, involved many countries in the international

research community, and made internationalization of the R&D process seem more familiar

and feasible. The following case (Table 6) of the Indian state of Andhra Pradesh and its

capitol city of Hyderabad illustrates actions taken by governments interested in building up

an offshoring industry.

Table 1-6: Government Action to Build an Offshoring Industry: Andhra Pradesh

In the 1990s, the Indian state of Andhra Pradesh and its capitol city of Hyderabad

developed a public policy to create an IT-enabled services offshoring industry in their

locale. They created a government agency with the double entendre acronym APFirst

(Agency for Promoting and Facilitating Investment in Remote Services and Technology) for

this purpose. The government provided free right-of-way land for laying fiber optic cable

and donated a 55,000 square-foot office building with reliable electric power service to

encourage IT- enabled services firms to locate there. In 1999, the government created a

new incentive policy that provided 25% discounts on power bills to IT firms, exempted

software from sales taxes, and provided a rebate on the cost of land by up to 20,000

rupees per job created. In 2001, the Indian School of Business was enticed to relocate to

the city. The state created the Indian Institute of Information Technology to provide IT

education and the Information Technology Enabled Service Training Institute to offer

courses in English and other subjects of value to the ITES offshoring firms. The state also

declared the ITES industry to be an essential service, thus prohibiting its workers from

labor actions (just as in other critical industries such as water and police).

Sources: Atkinson (2004), Dossani and Kenney (August 13, 2004), Balatchandirane (undated “…Hyderabad…”)

There are some reasons why companies might not want to offshore. These have been

grouped in Table 7 into eight categories: (1) the job process is not routinized sufficiently to

offshore the work; (2) the job cannot be done at a distance; (3) the infrastructure in the

vendor country is too weak for the work to be carried out there; (4) offshoring the work

negatively impacts the client firm’s workplace; (5) there are risks to privacy, security, and

intellectual property of the client company from offshoring the work; (6) there are not

workers in the offshore company with the requisite knowledge; (7) the cost of opening or

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maintaining the offshore operation is prohibitive; and (8) miscellaneous other reasons.

Although each specific reason is placed in only one category, a number of the reasons could

fit in more than one category. Note that there is a certain parallelism between work that

firms might offshore (Table 3) and work they are unlikely to offshore (Table 7).

Table 1-7: Reasons a Firm Might Not Offshore Work

Category Specific Reason

Job process is not

routinized.

*Uncertainty about the nature of work; uncertain specifications in

some jobs.

*Project has a highly iterative development process.

*Applications involve complex processes that require frequent

intervention to fix algorithms or data.

*High-skill work such as research, process design, or business

analysis.

*The work involves system analysis.

Job cannot be done at a

distance.

*Face-to-face interaction is required for the job.

*It is too difficult to coordinate the non-standardized parts of a

project if they are geographically distributed.

The infrastructure is too

weak in the vendor

country.

*Telecommunications, transportation, or specialty vendors are

not adequate.

The offshoring impacts

negatively on the client

firm’s workplace.

*The company loses control of the work process.

*The company loses in-house expertise needed to maintain,

improve, or replace the offshored product or service.

*Worker morale in the client organization deteriorates because of

potential loss of job, loss of wage power, or deskilling of job.

There are risks to the

client company in

offshoring the work.

*The work requires security clearance.

*Giving the vendor’s employees VPN access to the clients

information systems makes security difficult.

*Data privacy and security are hard to control at the vendor site.

*It is difficult to ensure that the vendor will protect the client’s

intellectual property.

*The vendor may not be able or motivated to follow the privacy

and security mandates in legislation from other countries such as

HIPAA, Gramm-Leach-Bliley Act, Sarbanes-Oxley Act, California

State Bill 1386, and European Union Data Protection Directive.

*The vendor may not be able or motivated to meet professional

qualifications required to do certain kinds of work such as being

an accountant certified as required by the client’s country.

*Legal recourse to privacy, security, or intellectual property

problems is non-existent or unenforceable in the vendor country’s

legal system.

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There are not workers

in the offshore company

with the requisite

knowledge.

*Application domain knowledge is required to do the job.

*The work crosses multiple disciplinary boundaries.

*The work depends on craft or proprietary knowledge held only

by the client company’s staff.

*The work involves business as well as technical expertise.

Cost of opening or

maintaining the

offshore operation is

prohibitive.

*The client needs to implement new bureaucratic structures such

as explicit authority relations, operating procedures, and incentive

systems.

*There is an extra cost for evaluating vendors, managing

contracts, improving security, travel, and severance pay for laid

off workers.

*Alternatives to offshoring such as downsizing, consolidation, and

reorganization are more cost-effective.

Other reasons *Cultural issues exist between the vendor and client countries

(social behavior, attitudes towards authority, language issues).

*Gain occurs from being located near to other companies doing

similar work (agglomerated economy), e.g., jobs in complex

functions that need to be located near one another to thrive,

adapt, and innovate such as in activities in corporate centers or

less routine consulting practices.

There are also reasons that professions or countries might want offshoring not to occur.

If low-level programming jobs are shipped overseas, then there might not be a viable career

ladder for IT workers to climb in order to attain the higher-end IT occupations that people

hope will remain in the high-wage countries. Salaries of IT workers in the client (highwage)

countries might be pushed down by offshoring. The ingredients for innovation

(including labor, capital, knowledge, facilities, and technology) are threatened at home since

innovation is widely regarded as the driver of higher productivity and standard of living for a

nation. The locus of entrepreneurship begins to move offshore.

1.9 Is IT Still a Good Career Choice for People Working in Countries

That Ship IT Jobs Overseas?

Almost every day one can find stories in the US press about people losing their IT jobs

because their positions were sent to a low-wage country. Many of these stories quote

talented young people who are choosing careers in other fields because they believe there

are no longer opportunities in IT. There are fears that it will not only be low-level

programming jobs that are sent to low-wage countries but also jobs that require higher skill

levels and are more highly compensated. If the world really is flat, as Thomas Friedman

proclaims, and a job can as easily be done in Bangalore or Beijing as in Boston, then even if

the job remains in Boston, eventually the wages will fall in order to remain competitive with

wages in other parts of the world. One study has shown that if you are one of those who

loses a job to trade, the chances are that you will be paid less in your next job (Kletzer

2001).

All of this sounds bleak, but consider some interesting statistics on jobs as shown in Table

8 and on salaries as shown in Table 9. They are both based on data from the US Bureau of

Labor Statistics, one of the most reliable sources available. There is some lag in collecting

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and analyzing data so the most recent data is only from May 2004. Note what David

Patterson, a computer scientist from Berkeley who is president of the ACM, has to say about

these numbers:

“Moreover, most of us believe things have gotten much better in the year since the

survey was completed. Does anyone besides me know that U.S. IT employment [in 2004]

was 17% higher than in 1999—5% higher than the bubble in 2000 and showing an 8%

growth in the most recent year—and that the compound annual growth rate of IT wages has

been about 4% since 1999 while inflation has been just 2% per year?” (Patterson 2005)

How could it be that, at the same time jobs are being shipped overseas, the number of IT

jobs in the United States is growing rapidly and is even higher than at the height of the dotcom

boom? There are several possible explanations, but we do not have adequate data to

identify the one at play. One possible explanation is that the very companies that are

sending jobs overseas are prospering from the lower costs of overseas labor which is

enabling them to grow and create new jobs in the United States and elsewhere. Another

possible explanation is unrelated to offshoring except that the background factors that make

it possible are the same background factors that make offshoring possible, namely, many

industries are being reorganized to make them more productive through the use of IT.

Catherine Mann, the economist from the Institute for International Economics mentioned

earlier in this chapter, has conducted a study of Bureau of Economic Analysis data for the

years 1989-2000. (More specifically, her data is taken from BEA Digital Economy 2002,

Table A.4.4) She has found a strong correlation for industry sectors between high

productivity growth and high investment in IT (Mann 2004). She has also identified a

number of sectors that still have low IT intensity and thus are poised to take off as IT is

introduced. These include health care, retail trade, construction, and certain services. As

IT becomes more pervasive in society, there are more jobs involving either pure IT skills or

combinations of IT skills and skills associated with a particular domain such as finance or

health care. Most of the forecasts suggest that perhaps 2 to 3% of US IT jobs will be lost

annually to offshoring on average over the next decade. With the expanded use of IT in

society, it is very possible that the total number of IT jobs will grow at more than a 3% rate

over the decade. Thus it is not surprising that the US Bureau of Labor Statistics forecasts

that three IT occupations will be among the ten fastest growing occupations over the

coming decade (BLS 2002).

Even if the IT job market is a growth area over the next decade, some types of jobs are

likely to fall off, probably including routine programming jobs. As explained in Section 1.8,

there are many reasons that companies do not send work offshore so there are likely to be

jobs in almost every IT occupation to be found somewhere in the United States; but

perhaps in some of these specific occupations there will be fewer jobs that there are today.

It is very unlikely that the United States will be completely devoid of even these most atrisk,

routine programming jobs ten years from now.

There are no fail-safe recipes for having a successful IT career, but there are many things

people can do to make themselves more attractive to employers. They can get a good

foundational education and keep up with current technology. They can improve soft skills

such as oral and written communication and teamwork skills. They can get management

training and experience. They can learn the processes of a domain in which IT is likely to

be increasingly important in the future such as in the health disciplines. They can be

prepared to work on tasks that are less routine and that require regular discretionary

judgment or that require regular interaction with others (e.g., with customers or domain

specialists within the company). They can seek out jobs that involve knowledge of trade

secrets or fundamental processes of the company or that are involved with national

defense. They can learn about other cultures, the technologies for doing work in a

geographically distributed fashion, and other things about managing distributed work so

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that they can take advantage of offshoring instead of being a victim of it. They can gain a

wide array of experiences so that they can be employed flexibly by a company and so that

they gain an overview of the way IT is being used in the company and its industry sector.

There are also some things that American (or British or German or Japanese) society can

do to assure that there continue to be good IT jobs for their workers. They can nourish the

innovation base that creates these jobs. This can be achieved by adequately funding

research and development, improving the educational system at all levels, making sure that

there continue to be opportunities for foreign scientists and technologists to study and work

in the country because of their important role in driving innovation, and developing and

enforcing rules for fair competition in the international marketplace. These issues are all

discussed in the policy chapter (Chapter 8).

Table 1-8: IT Employment in the United States (US Bureau of Labor Statistics)

Employment

May Nov. May Change, May 2003

to May 2004

Occupations 1999 2000 2001 2002 2003 2003 2004 # %

Computer and

Information Scientists,

Research

26,280 25,800 25,620 24,410 23210 23,770 24,720 1,510 6.50%

Computer Programmers 528,600 530,730 501,550 457,320 431640 403,220 412,090 -19,550 -4.50%

Computer Software

Engineers, Applications 287,600 374,640 361,690 356,760 392140 410,580 425,890 33,750 8.60%

Computer Software

Engineers, Systems

Software

209,030 264,610 261,520 255,040 285760 292,520 318,020 32,260 11.30%

Computer Support

Specialists 462,840 522,570 493,240 478,560 482990 480,520 488,540 5,550 1.10%

Computer Systems

Analysts 428,210 463,300 448,270 467,750 474780 485,720 489,130 14,350 3.00%

Database Administrators 101,460 108,000 104,250 102,090 100890 97,540 96,960 -3,930 -3.90%

Network and Computer

Systems Administrators

204,680 234,040 227,840 232,560 237980 244,610 259,320 21,340 9.00%

Network Systems and

Data Communications

Analysts

98,330 119,220 126,060 133,460 148030 156,270 169,200 21,170 14.30%

Computer and

Information Systems

Managers

280,820 283,480 267,310 264,790 266020 257,860 267,390 1,370 0.50%

Computer Specialists, All

Other 130,420 130,420

TOTAL (The "Change"

columns do not

include "Computer

Specialists, All Other")

2,627,850 2,926,390 2,817,350 2,772,740 2,843,440 2,852,610 3,081,680 107,820 3.80%

Computer Hardware

Engineers 60,420 63,680 67,590 67,180 72,550 70,110 74,760 2,210 3.00%

TOTAL, including

Computer Hardware

Engineers ("Change"

columns do not

include residual

"Computer Specialists,

All Other")

2,688,270 2,990,070 2,884,940 2,839,920 2,915,990 2,922,720 3,156,440 110,030 3.80%

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Table 1- 9: IT Mean Annual Wages (source: US Bureau of Labor Statistics)

1999 2000 2001 2002 May-03 Nov-03 May-04

CAGR (1999-

May 2004)

May 2003 -

May 2004

Computer and Information

Scientists, Research

$67,180 $73,430 $76,970 $80,510 $84,530 $85,240 $88,020 5.60% 4.10%

Computer Programmers $54,960 $60,970 $62,890 $63,690 $64,510 $65,170 $65,910 3.70% 2.20%

Computer Software Engineers,

Applications $65,780 $70,300 $72,370 $73,800 $75,750 $76,260 $77,330 3.30% 2.10%

Computer Software Engineers,

Systems Software $66,230 $70,890 $74,490 $75,840 $78,400 $79,790 $82,160 4.40% 4.80%

Computer Support Specialists $39,410 $39,680 $41,920 $42,320 $42,640 $43,140 $43,620 2.10% 2.30%

Computer Systems Analysts $57,920 $61,210 $63,710 $64,890 $66,180 $67,040 $68,370 3.40% 3.30%

Database Administrators $52,550 $55,810 $58,420 $59,080 $61,440 $62,100 $63,460 3.80% 3.30%

Network and Computer Systems

Administrators

$50,090 $53,690 $56,440 $57,620 $59,140 $60,100 $61,470 4.20% 3.90%

Network Systems and Data

Communications Analysts

$55,710 $57,890 $60,300 $61,390 $62,060 $62,220 $63,410 2.60% 2.20%

Computer and Information

Systems Managers $74,430 $80,250 $83,890 $90,440 $95,230 $95,960 $98,260 5.70% 3.20%

Computer Hardware Engineers $66,960 $70,100 $74,310 $76,150 $79,350 $82,040 $84,010 4.60% 5.90%

3.90% 3.40%

3.80% 3.30%

11 24,720 5.60% 4.10% 3.60% 3.00%

412,090 3.70% 2.20%

CAGR 2% 425,890 3.30% 2.10%

1999 $100.00 318,020 4.40% 4.80%

2000 $102.00 488,540 2.10% 2.30%

2001 $104.04 489,130 3.40% 3.30%

2002 $106.12 96,960 3.80% 3.30%

2003 $108.24 259,320 4.20% 3.90%

2004 $110.41 169,200 2.60% 2.20%

267,390 5.70% 3.20%

74,760 4.60% 5.90%

1.10 Bibliography

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Job Migration Task Force Meeting (Oct.) Chicago, IL.

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The McKinsey Quarterly, No. 4.

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(Oct.) Chicago, IL.

Atkinson, R. 2004. Understanding the Offshoring Challenge. Progressive Policy Institute

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Dossani, R. and Kenney, M. 2004. Offshoring: Determinants of the Location and Value of

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* Burt Barnow took a leadership position in the writing of Chapter 2. Page 71

Authors: Ashish Arora, William Aspray, Burt Barnow*, Vijay Gurbaxani

Chapter 2: The Economics of Offshoring

This chapter provides background material on the economics of offshoring. The first

section deals with the economic theory applicable to offshoring, including discussions of why

firms engage in offshoring and what economic theory indicates the consequences may be

for individuals, firms, and nations. The second section covers the extent of offshoring; it

first cautions the reader about the difficulties in tracking offshoring activities, and then

provides estimates of current, recent, and projected offshoring activity in the United States,

Europe, India, and other countries. The third section draws general conclusions about the

economics of offshoring and identifies data that it would be useful to collect in order to

better understand offshoring.

2.1 The Economics of Offshoring: Rationale and Potential Impacts

From a long-term view, offshoring is a response to two developments: technical change,

especially in IT itself, and international differences in population and economic growth.

Advances in IT have made it possible to trade in what were previously untradable (or

difficult to trade) services such as software development, support, and maintenance. In

particular, as discussed in Chapter 1, the development of low-cost and high bandwidth

communications links that connect most corners of the globe have facilitated a massive

increase in the potential to move information around the world with virtually no time lag

and at low prices. This has allowed service providers in countries such as India and the

Philippines and manufacturers in China to coordinate and communicate with their customers

instantaneously. This ability to communicate has made a whole new set of sourcing

opportunities feasible that were previously unattractive due to the high costs. More rapid

population growth combined with increases in education levels outside the developed

countries has meant that countries such as India, Brazil, China, and the Philippines have

large numbers of young and talented workers who face limited opportunities for productive

employment and therefore have received relatively low wages in the local economy. The

combination of these developments makes for fruitful opportunities for gainful trade,

sparked by the sustained growth in demand for IT talent since the 1990s in the United

States and other developed countries.

Several additional factors make it easier for some countries than others to provide

offshore services. Even relatively low-skilled service jobs generally require literacy, for

example, help desk workers need to be able to look up reference material when needed.

Thus, countries with more educated workers are more likely to be able to handle offshored

jobs. Speaking the same language as the client nation is also beneficial for jobs requiring

communication with the client country; thus, India has an advantage over China for

receiving offshored work from the United States.

Some of the confusion and disagreement about the extent of offshoring stems from a lack

of agreement about whether goods are included as well as services, lack of precision when

applying the terms offshoring and outsourcing, and disagreements about whether direct

foreign investments are included in offshoring. For a discussion of some of these issues,

see Bhagwati et al.(2004).

In a free market economy, offshoring decisions are made primarily by private firms

seeking to maximize profits. The decision to offshore the production of goods or services to

another country can be implemented in one of two ways. A firm may choose to source the

good or service from a foreign provider that could be either an unaffiliated firm or a captive

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organization such as a subsidiary. (A captive organization is one which has its operating

decisions dictated by another organization. This might be, for example, because the captive

organization is owned by the captor organization or because there are strong economic

incentives for them to follow the dictates of the captor.) A firm’s choice to produce a good

or service itself or to outsource it to an unaffiliated firm is often referred to as the “make

versus buy” decision and can apply both to domestic and offshore situations. It is worth

pointing out that the degree of outsourcing of IT services to specialists has been increasing

significantly in developed countries over the last decade, initially to domestic providers and

recently to both domestic and offshore providers.

Firms consider any offshoring that they undertake to be in the best interests of their

stockholders. The theory of comparative advantage indicates that, if each country

specializes in the production of goods where it has a comparative (relative) advantage, both

countries can enjoy greater total consumption and well being in aggregate by trading with

each other. In our context, if providers in countries such as India have a relative advantage

in the provision of software services, for instance, then it would be beneficial for US firms

that utilize these services in their operations to source the services from Indian providers

and focus their scarce resources on activities in which they have a relative advantage. Note

that we do not say whether these are captive or outsourced providers since that decision

will depend on a variety of factors such as whether the service creates valuable intellectual

property. Likewise, the gains from trade are generally beneficial to the service provider’s

host country. In countries such as India, employees at software firms have seen significant

increases in their incomes even as the number of employees such as software engineers

increases rapidly. Similarly, revenues and profits at these firms are growing rapidly.

Services can also flow from developed countries to developing countries. For example,

companies based in developed countries such as ABN Amro, ING Bank, Prudential, and

Citibank are capturing significant market share in developing countries in numerous service

industries such as banking and insurance, and displacing workers in less efficient domestic

companies in these countries. In these sectors, the know-how possessed by these firms

provides them with comparative advantage. As Chapter 4 discusses, some of the IT service

firms headquartered in developed countries such as IBM Global Services and Accenture, are

adding workers from developing countries in order to take advantage of low wages, talent,

and location enabling them to compete directly with Indian software service firms such as

Infosys, Wipro, and TCS in the global software services industry.

What the theory of comparative advantage does not mean is that all members of society

will benefit from trade. In general, imports of an input have economic effects that are

similar to those of an increase in the supply of the input, namely, lower returns to the

suppliers of the input, lower costs of production, and lower prices for consumers. If the

input were a service, the wages and salaries of those producing the service would fall, but

so would the costs for firms that are buyers of the service. In the exporting country, the

opposite effects hold. That is, the returns to the owners or suppliers of the service or input

increase and the wages of the employees at the service providers increase due to the higher

demand. However, there are costs as well. In the short run, assuming lead time to develop

and scale service capacity, providers will often transfer capacity from a domestic market to

service the export market, raising costs to the domestic consumers of these services.

There have been relatively few studies estimating the economic impact of outsourcing and

most of those that exist have been based on European data and focus more on the

outsourcing of intermediate goods rather than services. Several studies identify cost saving

as the primary motive for outsourcing of intermediate goods, for example, Egger et al.

(2003). For the United States, Feenstra and Hanson (2001) construct industry-by-industry

estimates of outsourcing (of intermediate products) between 1972 and 1992 and find that

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outsourcing contributed substantially to an increase in domestic demand for high-skilled,

non-production workers and their wages.

European studies, such as Gorg and Hanley (2004), have used plant-level data for the

electronics industry in Ireland for the period from 1990 to 1995 to show that offshoring of

services had a positive, though not highly robust, effect on productivity growth1. Likewise,

Girma and Gorg (2003) find a positive impact of outsourcing of industrial services1 on

productivity in the UK manufacturing industries during 1980-1992, although they are unable

to distinguish between international and domestic outsourcing.

The studies, however, did not consider offshoring of services. Recent work by Mann

(2003) provides a back-of-the-envelope estimate that the first wave of offshoring, which

focused on global sourcing of computer hardware, led to a reduction in IT hardware costs of

10 to 30 percent in the 1990s and an annual increase in productivity of 0.3 percentage

points during 1995-2002, or $230 billion in additional Gross Domestic Product (GDP). This

fall in IT costs would be reflected in higher profits for producers and lower prices for

consumers. IT production workers lose, while firms and consumers gain. She goes on to

argue that, since a larger share of IT costs accrue to labor-intensive tasks such as software

development and systems implementation, the productivity impacts of offshoring these

tasks can be expected to be significantly higher.

Economists believe that trade generally leads to significant gains to society. These gains

are not inconsistent with employment losses in specific sectors that will cause economic

pain to the workers affected. To achieve an equitable result, many analysts believe that it

is important to establish a safety net that provides income and training opportunities to

affected workers. (See, for example, Atkinson (2004); Bivens (2004); Kletzer (2004); and

Mann (2004).) Components of the safety net should include unemployment insurance,

wage insurance, and retraining. This topic is discussed in more detail in Chapter 8.

A key assumption underlying the theory of comparative advantage is that the economy

enjoys full employment. Thus, this theory is best thought of as a theory of the long-term

where workers displaced by imports or offshoring find work in other sectors. By contrast,

most popular discussions of the offshoring phenomenon tend to focus on questions such as

“where will the new jobs be created” and “can the workers be retrained for these new jobs”?

In general, peering into the crystal ball to predict where and what types of new jobs will be

created is both difficult and unrewarding. A dynamic economy, such as that of the United

States, creates and destroys millions of new jobs in response to changes in tastes, and

more importantly, innovations and advances in technology. The US economy creates and

destroys more than 30 million jobs each year. In 1999, 32.9 million jobs were lost and 35.5

1 The authors find that international outsourcing generally had a positive effect on productivity, of

which the effect on the level of productivity can be attributed to outsourcing of material inputs.

Similarly, for international outsourcing of materials inputs, Egger, Pfaffermayr, and Wolfmayr-

Schnitzer (2001) find outsourcing of material inputs by Austrian manufacturing firms to the Eastern

transition economies increases domestic growth in total factor productivity, more so in capitalintensive

industries than in labor-intensive ones. Egger and Egger (2003) find that a 1 percent

increase in outsourcing of intermediate inputs to the Eastern countries relative to gross production

induces a shift in relative employment by about 0.1 percent in favor of high-skilled labor. Egger and

Egger (2001) find that outsourcing of intermediate products by EU manufacturing firms reduces

productivity of low-skilled workers in the short-run and increases it in the long run, an effect which the

authors attribute to imperfections in the EU labor and goods markets.

1 This study defines “industrial” services as “activities such as processing of inputs which are then sent

back to the establishment for final assembly or sales, maintenance of production machinery,

engineering or drafting services, etc.” (p. 5). They do not include “non-industrial” services such as

accounting, consulting, cleaning, or transportation services.

Page 74

million new jobs were created for a gain of 2.6 million jobs. In 2003, there was a net loss

of 100,000 jobs even though 30.2 million new jobs were created (BLS Business Employment

Dynamics). There is no guarantee that the economy will continue to create these new jobs,

but we can take some comfort from the historical evidence that thus far it has managed to

do so. The key to job creation is of course the ability of the economy to rapidly generate

and adopt innovations, that is, new types of goods and services, and productivityenhancing

process improvements.

Innovation is indeed an engine of economic growth, and perhaps the most important

source of productivity growth in developed economies. When there is rapid technological

innovation, as in the case of IT, there is a significant spillover effect to users of the

technology when the price paid for the technology is lower than the value received. This can

result in significant productivity and economic growth in the user sectors as well. Given

that IT is a general-purpose technology, the users are many and varied.

In general, trade stimulates innovation and economic growth in both trading partners.

However, Gomory and Baumol (2000) and Samuelson (2004) argue that innovation

opportunities create new possible conflicts of interest between trading partners. For

instance, insofar as offshoring stimulates innovation and productivity growth in countries

such as India, and more likely, Brazil, China, and Israel, in goods and services for which

developed countries such as the United States or Germany enjoy a comparative advantage,

this will cause the terms of trade to become less favorable for the developed nation. Simply

put, the comparative advantage of the developed nation becomes less valuable over time.

As a result, offshoring may impose permanent losses in the developed nation. In other

words, even if free trade is the best policy, it may well be that free trade, by stimulating

innovation overseas, may impose long-term losses. However, Gomory and Baumol’s

analysis shows that this conflict of interest is present when the two trading partners are at

similar stages of development. Since most offshoring involves countries at very different

levels of development, this conflict of interest is presently unlikely.

In the IT services sector, there is a related concern in the developed nations, particularly

in the United States. Currently, it is efficient to offshore low-end IT services such as coding

or maintenance, with high-end activities such as requirements analysis, design, and

research and development remaining in the developed country. However, the concern is

that eventually the “labs will follow the mills”, and high-end IT activities will also move

offshore. Were this to happen, the developed country might cease to be the technology

leader. There is some anecdotal evidence that some process innovations are moving

offshore. For example, in laptops, it used to be the case that contract manufacturers made

product to the design specifications of US vendors. Today, many of these companies have

moved upstream to design the product. Intel is designing processors at its R&D facility in

India. Likewise, software services firms have moved upstream to provide increasingly

sophisticated software solutions from more traditional applications, and to business process

services such as accounts payable, human resources, and even medical applications. Thus,

in addition to the static, resource allocation efficiency from free trade, one must also look at

the impact on the fundamental capabilities that underlie innovation.

These concerns reflect possible scenarios, perhaps even plausible scenarios. However, it

is not clear how likely they are. There are offsetting forces as well. In parallel with

offshoring, the inflow of skilled and trained workers into the United States has grown.

Though perhaps these inflows substitute for native-born workers in the short run, in the

longer run, they create all-around benefits by raising innovation. Moreover, it could be

argued that even a loss of technical leadership in one area could be beneficial by allowing

scarce talent and resources to be allocated to more promising areas such as nanotechnology,

bioinformatics, or genomics. The post-9/11 trend of a reduced rate of

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immigration should be of concern to the United States given that many other developed

countries are seeing increases in immigration of qualified professionals.

Arora and Gambardella (2005) suggest that the scenarios that result in a loss of US

technological leadership are very unlikely. In many industries, the locus of production and

the locus of invention are physically separated. This is particularly true when the body of

knowledge underlying the invention process has a strong scientific basis. Building on earlier

work by Lamoreaux and Sokoloff (1996; 1997), Sutthiphisal (2003) studied the location of

production and invention in three different industries during the Second Industrial

Revolution, namely, textiles, shoes, and the electric industry. He finds that, in general, the

locus of invention did not shift with the locus of production as the latter moved to other

locations. Moreover, he found that the link between location of production and invention is

weaker in the more science-based electric industry. Using data from a century later,

Mariani (2001) studied the location of R&D and production facilities by the Japanese

multinationals in Europe. She found that in low- and medium-R&D industries, R&D labs are

more likely to be located close to production facilities than in more R&D-intensive industries.

Chapter 5 discusses some of the current patterns in the globalization of research.

Can the United States specialize and keep its comparative advantage in the higher end?

The starting point for this discussion is to note that there are two key resources required to

remain the center of innovation in software: access to talented designers, software

engineers, and programmers along with proximity to a number of large and technically

sophisticated users. The United States dominates on both counts. Recall that in the 1990s,

there was considerable concern about Japan’s software factories (e.g., Cusumano 1991),

but there has not been a single successful Japanese software product that has developed a

global market (if one excludes the software that is a key component of gaming devices

which is not sold separately). To the extent that students are misreading the tea leaves and

moving away from studying computer science, the United States in particular could face a

longer-term problem in having access to talented software professionals. This topic is

discussed in Chapters 7 and 8.

The size and the openness of its culture and economy have given the advantage to the

United States over Japan and Western Europe in attracting talent from around the world.

The United States has been and continues to be a large producer of IT human capital for the

world, especially at the graduate level, and some of the students who study remain to work

in the country after graduation. The country has also been a magnet for technical workers

trained elsewhere. The United States as a destination for study and work has abated

somewhat in the past several years partly because of the harsher governmental regulations

in support of national defense.

Another global advantage of the United States is that most lead users are US-based. New

software applications depend largely on knowledge about demand and about the

applications domain. This is especially true for the substantial fraction of software used in

running businesses and business processes. Proximity to business activities is crucial for

innovations in such areas. Indeed, the development of new commercial applications or

solutions is a very special comparative advantage of the United States. On a more limited

basis, this benefit also accrues to other developed countries such as Germany where the

software giant, SAP, is based and dominates the market for enterprise software. In general

though, US industry is the largest user of IT in the workplace.

Globalization may reinforce this lead because we find that innovative companies from

Israel, Ireland, and even India are likely to move their operations to the United States to be

closer to their users. Sometimes, venture capitalists push for such a move as well. Other

intermediating institutions, such as legal services and thick and well functioning labor

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markets, are also important sources of advantage enjoyed by the United States that are not

likely to be eroded soon.

There are counter-tendencies as well. In so far as these professionals (be they Indian,

Irish, Israeli or Chinese) have a preference for staying in their home country where the cost

of scientists and engineers is lower, the cost of R&D activities that are human-capitalintensive

and relatively less intensive in physical infrastructure will also be lower offshore.

More broadly, the United States has several distinct capabilities – the best universities

and research institutions, highly efficient capital markets, flexible labor markets, the largest

consumer market, business-friendly immigration laws, and a large and deep managerial

talent pool. As a result, the evolution of business in the United States has followed a

consistent pattern: launch innovative businesses here, grow the business, and as products

and services mature, migrate lower-value-added components and intermediate services

over time to lower-cost countries. As more countries and regions enter global trade with

highly skilled and capable labor pools, this increases the amount of competition that US

companies and workers face. This competition produces an increased premium on the

innovation and productivity of the US workforce.

To continue growing the wealth of the United States and its individual workers, labor

productivity must grow at a rate that equals or exceeds the growth of wages. Labor

productivity can increase in a variety of ways but generally occurs through an increase in

worker skills combined with increased innovation in products and processes. Essentially,

growth requires capital investment in technologies that increase productivity and a focus on

innovation that results in new or transformed existing marketable products and in more

efficient processes.

In summary, economists have argued on both sides of the offshoring and free trade issue.

The arguments are sophisticated and nuanced, and the results often depend on whether the

underlying assumptions hold in the current context. While a majority of economists are

proponents of free trade, the underlying question is an empirical one and can be answered

by analyzing reliable data. As someone once said, “The difference between theory and

practice is greater in practice than in theory.” Unfortunately, there is a lack of data to help

understand the phenomenon, and more importantly, there are no data collection processes

underway that would help in conducting a statistical analysis of the empirical evidence.

It is important to distinguish among effects at the country, firm, and worker levels.

Because it is voluntary, offshoring benefits the firms that undertake it. Workers, on the

other hand, sometimes lose substantially from offshoring because they cannot instantly

(and may never) transfer their skills to other jobs that pay as well. At the country level, the

benefits of trade often outweigh the costs, but we have seen that this is not always the

case.

2.2 Data on the Current State of Offshoring and Projections for the

Future

“…there are currently no reliable statistical indicators of the extent or nature of global

outsourcing.” (Huws et. al. 2004)

The report that triggered public concern about the impact that offshoring would have on

US lives was produced by Forrester Research in 2002, indicating that 3.3 million US service

jobs would be lost to offshoring by 2015. This report was followed by many additional

studies, each with its own numbers, produced by private consulting firms, federal agencies,

and economists from academia and think tanks. These numbers ranged quite widely, in

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some cases differing by a factor of ten. How are we to know which numbers are correct?

This section discusses some of the general issues concerning data about offshoring. It then

considers what the existing data tells us about the current state of offshoring and about

projections of future offshoring activity. The greatest emphasis is on the United States (the

leading sending country), then on India (the increasingly dominant recipient country), but

data are provided about all the countries actively involved in offshoring to the degree that

we could identify data. Worldwide data was given in Chapter 1 and is not repeated here.

What Are the General Issues We Should Consider in Evaluating the Accuracy of Data About

Offshoring?

There are three basic points to consider in evaluating offshoring data. First, there is a

question of the definition of offshoring. Some reports include all service jobs, some include

a subset of the service jobs that pertain to professional and technical services (following a

category used by the Bureau of Labor Statistics (BLS) in the U.S. Department of Labor),

some include all IT jobs, some include only software jobs, some include IT-enabled service

jobs, some include other jobs with other criteria, and some reports are not precise in

defining what they are counting. Obviously, the numbers will vary considerably based upon

the definition used.

Second, it is not clear what should be considered a good measure of the extent of

offshoring. Many people count jobs or workers. In addition to the issue raised in the prior

paragraph about what kinds of jobs one has in mind, there are other considerations.

Suppose one wants to count the number of jobs lost in the United States or Western Europe

to offshoring. How does one know which jobs to count? Business decisions by companies

are complex and, while the press sometimes reports horror stories of employees being

asked to train IT workers from a low-wage country and afterwards being replaced by them,

it is rarely clear-cut whether a job has been lost directly because of offshoring. A company

might cut back on the number of workers in one location and add workers in another

location, or cut back on people in one occupation and replace them with workers in another

occupation. And this might be because of some good business reason other than labor

arbitrage that is taking advantage of the wage differentials in the two countries to save on

labor costs. It might be, for example, that one product line is declining and resources are

needed elsewhere in the company, or the company needs fewer workers in a particular field

because of automation of some aspects of the work or rationalization of the work process,

or because the company has a global strategy that it is trying to achieve and part of that

strategy involves building market presence in specific geographic locations.

One might instead want to count the number of jobs created in a low-wage country to do

offshoring for a high-wage country. There is, however, no necessary correlation, for

instance, between the number of Indian jobs created and American jobs lost. A company

might decide to hire more Indian workers to work on a project than the number of American

workers displaced because the cost of the Indian workers is so low and better results might

occur by dedicating a larger labor effort to it. An American worker and an Indian worker

might not have the same productivity rate because of educational level, work process,

infrastructure, technical tools available to support the work, or many other reasons. The

literature gives examples where American workers are clearly more productive than the

Indian workers, and other examples that show the opposite. In particular, work processes

often are reengineered before being implemented in India, and the reengineered process

sometimes leads to significant increases in productivity. Also, in some lower level jobs (for

example, working in a call center), Indian companies are on average able to recruit workers

to do these tasks who are much more highly educated than the average American holding

that job. There is also confusion in the statistics about whether to count only the jobs

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newly created that are focused on doing software work for export versus counting all new

and existing jobs with this focus.

One might want to focus on the monetary value of the business rather than on the

number of workers who perform the work. This, too, is difficult to measure. One of the

problems is that a significant portion of the work that is done for multinational corporations

is done by their subsidiaries in countries such as India. The work that is conducted is then

regarded as an internal operation of the multinational, and this may make it difficult to

identify the monetary value of the work performed offshore or even to know when to

consider something as offshoring and when to regard it simply as a product or service

developed by a multinational through several of its divisions located in different countries.

This is a serious issue in measuring offshoring because balance-of-payments data tells us

that intrafirm trade represents 71% of all business, technical, and professional services

imported into the United States and, moreover, in the period 1997-2002, it was increasing

faster than imports from companies not affiliated with a multinational (UNCTAD 2004).

Another issue is that offshoring of complex products or services often occurs by dividing

up the labor and having some of it done within the client company, some done by one or

more vendors, and some purchased as components. In these cases, it is often difficult to

value fairly the portion of the product or service that has been outsourced. A recent

European study addressed these issues:

In its legal sense “outsourcing” refers to a business activity, involving the production

of either goods or services, purchased by an organization from an external supplier

rather than internally. It is, in other words, “subcontracting.” However, in the

current context of rapid organizational change, determining what is “internal” and

“external” is increasingly difficult. Mergers, demergers, strategic alliances, publicprivate

partnerships, and a variety of different forms of organizational disaggregation

– including those resulting from business process re-engineering – are increasingly

common. If a company is restructured on the basis of separate cost or profit

centers, for instance, should transactions between them be regarded as ‘outsourcing’

or merely as internal accounting flows?” (Huws et. al. 2004, p. 3)

If one wants to focus on the long-term impact of offshoring, the appropriate metric might

be jobs lost or created, or the monetary value of offshoring business over time rather than

at any specific point in time such as today. This kind of data tends to be of two types. One

type analyzes the nature of work to determine the number of jobs that might be vulnerable

to offshoring without making any claims that all or any particular portion of these jobs

would be transferred from the high-wage to a low-wage country. The other type analyzes

the number of jobs that will actually be sent overseas (or the monetary value of actual

offshoring business) by a certain date. Even in cases where the methodology is sound and

soundly applied, projections about the future are much less likely to be accurate than data

about today’s or yesterday’s situation since it is difficult to predict all the factors that will

come into play over time.

These two types of analyses introduce additional data issues. Vulnerability analyses are

less prone to errors because they require fewer assumptions than the other types of

analyses. To conduct a vulnerability analysis, all that is required is to identify industries

whose work could be transferred offshore and count the number of workers and their

occupations in the identified industries. To some extent, the list of vulnerable industries is

subject to change as new technologies and price changes can affect the list of industries

that are vulnerable to offshoring. A more important problem with vulnerability analyses is

that they tend to produce very large numbers that may bear little relationship to the actual

amount of offshoring that will take place. For example, all manufacturing, mining, and

agricultural activities could be replaced by offshore activities. Thus, other than pointing out

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which industries and occupations are immune from offshoring, assessments of the number

of jobs vulnerable to offshoring provide a very high upper bound that may be of little

practical value. As described in the following, projections of how much offshoring will occur,

while more useful in theory, are plagued by additional problems.

In addition to issues with the definition of offshoring and what constitutes a good measure

of it, there is an issue concerning the source of the statistics. There are four major

categories of data providers: government agencies, trade associations, consulting firms,

and universities and think tanks. At least in the United States and Western Europe, the

national governments provide data that is among the most trustworthy. For example, the

US government collects large and often fairly complete data sets, taking advantage of its

ability to compel business organizations and individuals to report certain kinds of data under

penalty of law. Most of these federal agencies employ well-trained and experienced

economists and demographers who typically use appropriate methodologies and open their

methods and assumptions to scrutiny. In the United States and a number of other

countries, the data-collecting and reporting agencies have been relatively unbiased – not

subject, for example, to political whims but instead trying honestly to determine what the

data tells us. Some analysts have argued, however, that US government data and reports

may indeed be either inferior to data from other sources or biased. For example, the

Economic Policy Institute (2004) has noted that the Bureau of Economic Analysis (BEA) data

on US imports of software from India shows much lower levels and a different trend (flat or

declining compared to a rapid increase) than data provided by NASSCOM, the Indian trade

association (see Figure 1). Business Week Online (2005) points out how the tone in US

Department of Commerce reports on the effects of offshoring changed markedly when one

of their reports was updated with the authorship shifted from career staff to political

appointees.

Figure 2-1. U.S. Software imports from India

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Projections, however, require more than simply collecting and analyzing data. Models

must be developed to extrapolate trends, and decisions must be made on turning points and

when new forces will affect trends. Thus, it is not surprising that projections related to

offshoring, and other labor market variables as well, are subject to error, particularly when

projecting over longer periods of time. Even federal agencies are often far off the mark with

projections especially if these projections extend far into the future. The BLS periodically

assesses the accuracy of its projections. The most recent BLS review of its general

occupational projections shows that although BLS does reasonably well in projecting overall

employment in broad occupational groupings, the projections do not do as well in dealing

with specific occupations (Alpert and Auyer 2003). In projecting employment growth from

1988 to 2000, the BLS projected an increase of 15.3 percent, but employment grew by 21.7

percent over the period. The most serious problems in projecting occupational employment

patterns resulted from problems in anticipating changes in staffing patterns. Examples of

particularly large errors include the category of gas station attendant, which was projected

to grow from 308,000 to 331,000, but actually fell to 140,000, and travel agents, whose

ranks were expected to grow by 54 percent but whose numbers declined by 6.2 percent

(Wessel 2004). An earlier outside review of the BLS occupational projections found that

BLS tended to underpredict the growth of occupations requiring a college education (Bishop

and Carter 1991).

Even when government agencies do a good job of collecting data and making projections,

they generally collect data that helps them assess issues that have occurred in the past so

when a new phenomenon arises (such as offshoring), it is not clear that the data that

federal agencies have been collecting and the analyses they have been performing will

answer the policy questions that now arise. This is generally true for both the federal data

from most countries and for the data collected by pan-national organizations such as the

United Nations, the International Monetary Fund, and the Organization for Economic

Cooperation and Development (OECD).

The data provided from the other sources is potentially more problematic. Trade

associations, such as the Information Technology Association of America (ITAA) and the

National Association of Software and Service Companies (NASSCOM), the trade association

for the software industry in India, have access to large data sets from their members.

However, the members of these organizations are not necessarily representative of the

totality of producers or consumers of information technology so the data from these

organizations may not accurately represent the full story of what is going on. Moreover,

these organizations are partisan to their members, and they may craft their data studies or

reporting of these studies in ways that are favorable to the interests of their membership.

The consulting firms have a strong interest in increasing their business based on their

statistics. It is in their interest to provide numbers that demonstrate to potential clients

that there is a problem that needs fixing. Most of the consulting firms keep proprietary the

method by which they produce their projections so it is hard to evaluate what their numbers

mean. In fact, many economists are skeptical of the methods these firms use. Much of the

alarmist data about the impact of offshoring on job loss in the United States and Europe has

been generated by the consulting firms. All of this discussion indicates that it is difficult to

get accurate data about the amount of offshoring currently going on and that is likely to

take place in the future.

What Does the Data Tell Us About the Size and Impact of Offshoring in the United States?

Although the Forrester Research numbers are the most widely quoted, it would be

preferable to be able to use other sources because Forrester is an interested party and the

firm is not forthcoming about its methodology. One would like to use US federal data, if

possible, for quality and objectivity. The most relevant federal data source is the Bureau of

Labor Statistics Mass Layoff Statistics (MLS) series. Unfortunately, the MLS has serious

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shortcomings for this purpose in that it both undercounts and overcounts layoffs. It counts

only relatively large layoffs (at least 50 employees within a five-week period) and only

layoffs at companies that employ at least 50 employees; thus it undercounts by not

counting all small businesses and by not counting companies that lay off people for

offshoring purposes in smaller numbers or over a longer period of time. The MLS also

overcounts in that its numbers include people who are laid off for many reasons, including a

number not relevant to our interest such as bankruptcy, financial difficulties of the

company, movement to other locations within the United States, or change of company

ownership. BLS reports that these latter reasons are more common than layoffs for

outsourcing, both domestic or across national boundaries.

For the IT industries (by which the BLS means the communications equipment,

communication services, computer hardware, and software and computer services), MLS

only identified 7,923 people affected by movement of their jobs during the period January

through September 2004. Of these job relocations in the first three quarters of 2004, 70%

of the jobs were moved within the United States and 80% were moved within the same

company. When the jobs were moved contractually to another company, 40% of the jobs

were moved outside the United States. These numbers appear unreasonably low.

A study by Bronfenbrenner and Luce (2004) used online media tracking and corporate

research to identify offshoring job losses in the United States. This study found that the

MLS grossly underreported job loss due to offshoring. It estimated that 206,000 jobs were

shifted overseas in 2002 and 406,000 were moved in 2004. The authors argue that their

method, while imperfect, probably undercounts job migration because not all losses are

reported in the media and their search tools did not fully capture job losses that are

reported only in the local media, a common place for such losses to be reported.

2Even if the MLS data does not provide exact numbers, it might serve as a representative

sample from which one could learn about trends (for example, the year in which losses peak

in a particular field of IT). If this sample is indeed representative, computer hardware,

software and computer services, and communications equipment had their peak losses in

2001, while communications services had its peak losses in 2002. The Bronfenbrenner and

Luce study discovered that the largest job losses came from the midwestern states in the

United States, and that there have been rapid increases in job movements in IT, call

centers, and white-collar jobs to India.

Another potential source of federal data on offshoring comes from the US Department of

Commerce’s Bureau of Economic Analysis (BEA). However, some economists believe that

the BEA numbers seriously underreport software imports to the United States. For

example, BEA reports the United States imported $76 million in software from India in

2002, whereas the Indian software trade industry association NASSCOM reports Indian

software exports to the United States at $2,800 million that same year (see Figure 1). A

small part of this difference can be attributed to differences in definitions but not nearly the

entire amount. The US Government Accountability Office (GAO) noted the shortcomings of

the BEA data on offshoring as follows: “In addition to the lack of quarterly survey data for

unaffiliated transactions and lack of quarterly product detail for affiliated services, there are

reliability issues related to the mandatory filing requirements and survey coverage.”

(Government Accountability Office 2003, p.62).

2 This study defines “industrial” services as “activities such as processing of inputs which are then sent

back to the establishment for final assembly or sales, maintenance of production machinery,

engineering or drafting services, etc.” (p. 5). They do not include “non-industrial” services such as

accounting, consulting, cleaning, or transportation services.

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The BEA data nevertheless show some trends. Imports of business, professional, and

technical services into the United States increased by 77% to $38 billion between 1997 and

2002. US investments in developing countries that offshore services were small compared

to investments in developed countries, and most services created abroad are sold to non-US

markets.

Turning to trade association data about offshoring and the United States, the Information

Technology Association of America (ITAA) is the principal provider. ITAA is an organization

that represents 350 US-based Internet, software, service, and telecommunications

companies. It reports that 372,000 software and services jobs were lost between 2000 and

2003, with only 104,000 lost to offshoring. ITAA estimated that 90,000 new software and

service jobs were created in the United States in 2004 due to increased economic activity.

The largest amount of data (that is also the most suspect data) comes from the

consulting firms. Table 1 provides information about the impact of offshoring on the United

States based on reports and projections from consultants. The numbers generally indicate

that 12 to 14 million IT and IT-enabled jobs in the United States are vulnerable to relocation

through offshoring. Annual losses range from under 200,000 to about 300,000 for service

jobs lost from the United States due to offshoring. The number of IT jobs lost is somewhat

lower than these estimates because the estimates include service jobs such as working in

call centers and possibly in other IT-enabled services such as business process and

knowledge process outsourcing. The numbers from the American Electronics Association

might seem to be contradictory to the other data, but it should be remembered these are

net losses in the industry so they include losses not only to offshoring but for other reasons

such as company downsizing or bankruptcy, and these losses are offset by newly created

jobs. The consensus seems to be that about 20% of US companies are currently offshoring

work but that the percentage will rise considerably over the coming years. Bednarzik

(2005) concludes that “employment trends by industry and occupation suggest that

offshoring in the information technology sector occurs, but not to a great extent.” These

numbers also do not take into consideration jobs that are created by offshoring.

The current value of offshore contracts from the United States seems to be in the $10 to

20 billion range, and most analysts believe there will be rapid growth in these numbers over

the coming few years. It should be remembered, however, that we do not know the

methods used to arrive at these numbers and how independent the data from one

consulting firm is from that of another. We do not know, however, of any body of extant

raw data that serves this analysis well.[BSB1]

Table 2-1: The Impact of Offshoring on the United States

Source Data reported Statistic

I. Current or Recent Offshoring

Forrester (2004) US service jobs lost in 2003 315,000

Forrester (2004) US service jobs lost by end of

2005

830,000

Goldman Sachs (2004) US jobs lost in past three years 300,000 to 400,000

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Dossani (2005)[BSB2] Software workers in the United

States

1,200,000 software

engineers; 500,000

programmers

Evalueserve (2004) IT jobs offshored year ended

March 2004

212,000 (60% to India)

Evalueserve (2004) Call center jobs offshored year

ended March 2004

136,000 (90% to India)

Gartner (2004) Fortune 500 companies

expected to offshore some IT

work by end of 2004

40%

Gartner (2003) IT industry and employment 500,000 jobs by end of

2004

Meta Group (2004 Annual IT

Staffing and Compensation

Guide)

US companies using offshore

labor in software

19%

American Electronics

Association (2003

Cyberstates report) [Seeley

2003]

Jobs lost in 2002 in the US

software services sector

30,000 (compared to

146,000 the year before)

American Electronics

Association (2003)

Jobs lost in 2002 in the US

software industry

150,000

American Electronics

Association (2003)

Jobs gained in 2002 in US in

high-tech R&D

7,000

Washington Alliance of

Technology Workers

(CBSNEWS.com, 2005)

Jobs lost in the US IT sector

March 2001 to April 2004

403,300

Washington Alliance of

Technology Workers

(CBSNEWS.com, 2005)

Percentage of IT sector jobs in

San Francisco area lost March

2001 to April 2004

49%

United Nations Conference on

Trade and Development

(World Investment Report

2004)

Average percentage annual

growth in US imports of

computer and data processing

services, 1992-2002

31%

Bajpai et al. (2004) Percentage of companies that

have offshored work (survey is

mostly but not exclusively of

US companies)

25%

Bajpai et al. (2004) Percentage of companies that

have already or plan to

offshore work

79%

IDC Value of offshore contracts

from US in 2005

$17.6 billion

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ITAA[BSB3] Value of offshore contracts

from US in 2003

$10 billion

II. Estimates of Workers Vulnerable to Offshoring

Bardhan and Kroll (2003) US workers in service jobs

vulnerable to offshoring

14,000,000

Progressive Policy Institute

(2004)

US IT jobs vulnerable to

offshoring

12,000,000

III. Projections of Offshoring

Wired magazine (Pink 2004) Service jobs leaving the United

States each year for the

foreseeable future

200,000

Prism (2004) meta-analysis Percentage of IT jobs lost from

US over next five years

7% to 8%

ITAA[BSB4] Value of offshore contracts

from US in 2008

$31 billion

Deloitte Research (2003

report cited in GAO 2004)

Financial services jobs that

may move offshore

850,000 (15% of

industry employment)

Forrester (2004) report cited

in GAO (2004)

U.S. service jobs lost by 2015 3,300,000

Goldman Sachs (2003 report

cited in GAO 2004)

Services and manufacturing

jobs lost over coming decade

Up to 6 million jobs

Evalueserve (2003) All jobs lost 2003-2010 1.3 million worst case

Evalueserve (2004A) Total jobs offshored in IT and

non-IT business process

operations (BPO) in 2010

775,000 IT jobs

1,414,000 non-IT BPO

jobs

Evalueserve (2004B) Growth of value of knowledge

process offshoring (KPO) from

2003-2010

From $1.29 billion in

2003 to $17.0 billion in

2010 (46% annual

growth rate)

Shaw quoted in McDougall

(2005)

IT jobs moving offshore in 30

years

30% of IT jobs offshore

within 25-30 years

Gartner quoted in McDougall

(2005)

Percent of U.S. IT jobs

offshored in 2005 and 2015

Will increase from 5% in

2005 to 30% in 2015

Two studies estimated the number of jobs in the United States that are vulnerable to

offshoring, and they found 12 to 14 million jobs could be offshored (Bardhan and Kroll

2003; Progressive Policy Institute 2004). Both studies note that their figures represent an

upper bound on offshoring activity that could occur not a projection of what will take place.

Thus, these studies are useful not so much for the numbers they provide as for identifying

sectors and occupations subject to offshoring. Bardhan and Kroll, for example, include in

their 14 million jobs vulnerable to offshoring office support, business and financial support,

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computer and mathematics professionals, paralegals and legal assistants, diagnostic

support service jobs, and medical transcriptionists.

A number of studies provide projections of offshoring activity in the United States. It is

difficult to make comparisons among the studies for several reasons. The major obstacle is

that the studies measure different sectors of the economy (e.g., IT, services,

manufacturing, business processing operations, knowledge process offshoring), use

different measures of the extent of offshoring (e.g., jobs lost, percent of jobs lost, value of

jobs or business lost), and different start and end points. Few of the studies provide details

on how they developed their projections which makes it difficult to assess the

reasonableness of the assumptions and the soundness of the methodology. The

Evalueserve studies provide more details on their methods so one can assess the

assumptions and methods better than for most other studies. For example, a critical

assumption in Evalueserve’s work is that there will be a large shortage of labor in the United

States and that a significant part of the solution will be from offshoring. Since Evalueserve

has described its assumptions and methods in some detail, other analysts can make their

own assessment of how reasonable these assumptions and methods are.

All the projections indicate that offshoring of service jobs in the United States in general

and of IT jobs specifically will continue to grow, but there is some disagreement about how

rapidly the growth will take place. Some of the studies project absolute numbers of workers

lost over a given number of years such as Forrester’s projection of 3.3 million service

workers by the year 2015. The problem with these projections is that most of them do not

give a baseline for understanding the significance of the job losses. They often do not tell

you the size of the population from which these projected losses will be taken. In fact, it is

a difficult task to count the number of IT or service workers in the United States. Here is

one part of a lengthy analysis of this issue from a Computing Research Association study

done in 2000 about the IT workforce.

Commerce used the narrow definition of the Bureau of Labor Statistics

classifications: computer scientists and engineers, systems analysts, and computer

programmers. The Information Technology Association of America (ITAA) used a

broader definition: any skilled worker who performs any function related to

information technology, which itself is defined as the "study, design, development,

implementation, support or management of computer-based information systems,

particularly software applications and computer hardware." (Freeman and Aspray

2000)

Not surprisingly, different definitions lead to different numbers. The Bureau of Labor

Statistics counted a little more than 2 million workers in 1997 and about 3 million today.

Between 2000 and 2004, the ITAA has counted between 10 and 11 million IT workers.

Service workers account for a very significant portion of the American labor force,

amounting to many tens of millions of workers. Some significant fraction of these service

workers are enabled by information technology, but it is hard to count how many and to

what extent.

Some of the other studies project in terms of the percentage of the jobs lost. These vary

significantly in the percentages they quote and the length of time over which this job loss

takes place. But perhaps more importantly, it is hard in some cases to know what a given

percentage projection means or to compare across these projections by different

organizations since their meanings are often different from one another. When a study says

that 25% of the US IT jobs will be lost by a given year, does it mean that the IT workforce

in the United States will be a quarter smaller than it is today? Does it mean that there will

be three IT jobs in the United States at that date in the future for every IT job in another

country doing work for a US firm? Are the numbers calculated on a base of the number of IT

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jobs today or at that time in the future? Would it matter if there were a sizable number of

IT jobs in other countries servicing the US economy if the number of IT jobs that remained

in the United States continued to grow?

Some of the projections are for specific slices of the offshoring market. For example,

Evalueserve (2004B) has projected a high rate of growth—46 percent annual compound

rate of growth—in what they term knowledge process offshoring (KPO). Evalueserve

distinguishes KPO from other business process operations (BPO) by the high level of

knowledge intensiveness required. Examples of opportunities in KPO include intellectual

property research; equity, financial, and insurance research; data search, integration, and

management; analytics; and research and information services in human resources

(Evalueserve 2004B, p. 4). What happens in the KPO slice that is developing from a small

base, making it easier to have high growth percentages, may well not be true for other

segments of the offshoring industry.

How do we put all this in perspective? Looking only at the number of jobs lost to

offshoring is a narrow and one-sided way of looking at the situation. If one wants to know

how many jobs there will be for IT workers in the United States in the future, one needs to

look not only at all the ways in which jobs are lost (including not only those moved offshore

but those lost through companies downsizing or going out of business) but also look at the

number of new jobs that are created in the IT occupations.

It is useful to consider what has happened over the past five years and compare that

situation with some of the projections just mentioned about IT job growth. The reports

discussed earlier in this section indicate that the United States has lost several hundreds of

thousands of jobs to offshoring since the height of the dot-com boom. Does that mean that

we have fewer jobs today in the United States in the IT field than we did then? The last

section of Chapter 1 contains an analysis of recent US Bureau of Labor Statistics numbers

(see Table 8). It shows that the number of US IT workers is actually higher today than in

1999, at the height of the dot-com boom, despite the hundreds of thousands of jobs lost to

offshoring. People who study the overall US labor market will not be surprised to learn that

the situation is not as dire as it is made out to be by those who dwell on the offshoring

losses. This is because history shows tremendous and continuing churn in the American

labor market with massive numbers of jobs lost and jobs created each year, but with a fairly

consistent pattern that the number of jobs created is larger than the number of jobs lost.

These patterns do not hold true for all occupations of course, we have significantly fewer

telephone operators than we once had, for example, but the Bureau of Labor Statistics in its

ten-year forecasts continue to believe that the IT occupations will experience overall

sustained growth and, in fact, several IT occupations will be among the fastest growing

occupations in the next decade. The ITAA study mentioned previously also suggests that

the number of IT jobs created in the United States in the future will be robust.

One can similarly ask about the effect of offshoring not on jobs but on wages for US IT

workers. The same Bureau of Labor Statistics data just cited indicates that, since the height

of the dot-com boom and throughout the dot-com crash, even through a recession in the US

economy, IT wages have continued to rise at about twice the percentage of inflation.

Wages did not rise at the same rate in all IT occupations. High-skill jobs rose at the highest

rates, for example, computer science research salaries rose at 5.6% per year and computer

systems manager salaries at 5.7% per year. Wages for low-skills jobs rose less rapidly.

For instance, computer support personnel wages rose at only 2.1% per year, fairly close to

the rate of inflation during this time. Even the much talked about programmer, whose job

is expected to be particularly vulnerable to offshoring, had wages rise by a healthy 3.7%

per year.

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What will happen in the future is hard to predict. If the United States remains innovative

in the IT field and if this innovation continues to have an important positive influence on the

US economy as was the case throughout the 1990s, then it is likely that the United States

will continue to create large numbers of jobs for IT workers. If the country does not

continue to promote innovation and it cedes large portions of its IT industry to other

countries, then the future is likely to be much bleaker for American IT workers.

What Does the Data Tell Us About the Size and Impact of Offshoring in Countries Other

Than the United States That Offshore Work?

EUROPE OVERALL

The European Union is the largest offshorer of IT software and services after the United

States. In one project of the European Commission’s Information Society Technologies

Programme, known as the STILE project, there was an effort to cull data on the ITproducing

sector in Europe. The study group tried to use the accepted classification

scheme, Nomenclature Generale des Activites Economiques dans les Communautes

Europeenes (NACE) (General Industrial Classification of Economic Activities within the

European Communities). They found that this was not particularly useful because IT

activities are in many cases bundled with non-IT activities in the classification codes, and it

was impossible to separate out services from products. More generally, there seems to be

very little data, if any, collected by government organizations that provides information

about the state of offshoring in Europe. As one major survey of the literature on European

offshoring summarizes:

It is important to emphasize, along with the OECD (van Welsum, 2004) that there

are currently no reliable statistical indicators of the extent or nature of global

outsourcing. It is not possible, either through the trade statistics or the EU

occupational and employment statistics, to track statistics of imports and exports of

business services to identify with any accuracy which components of these services

represent jobs.

For evidence we must therefore look to the results of market research, one-off

surveys and case studies or anecdotal evidence. It must be emphasized that these

vary in their reliability and their conclusions. They may be coloured, either positively

or negatively, by the specific interests of the agencies who commissioned them,

depending on their point of view. In between, lie many analyses which strain for

objectivity but are hampered by the lack of solid empirical evidence….

An even greater confusion exists in the EU [than in the United States] where there

are notably few academic, systematically led investigations in the area of European

and offshore outsourcing. Estimates of the impact on Europe are vague, especially in

relation to outsourcing to smaller Asian countries and eastern European states.

(Huws et. al. 2004, p. 10)

Table 2 provides an overview of some of the consultant data on the extent and impact of

offshoring in Europe. The amount of offshoring is clearly at substantially lower levels than

in the United States. These reports indicate that only about 5% of European businesses are

currently offshoring, and not quite a third of European companies are even planning for

offshoring. Huws et. al. (2004) point out that most studies agree that 2 to 3% of all EU

service employment will be lost to offshoring by 2015 but notes that this loss is likely to be

less than the number of new jobs created so that the European service industry is likely to

expand its employment over time.

It is true today that Europe overall is not losing IT service jobs. Even at the country level,

this is mostly true, and where there are national losses, in every country other than

Denmark, any losses in computer jobs have been more than offset by growth in business

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service jobs (Eurostat, Community Labour Force Survey). Other than the United Kingdom,

Western Europe has a decided preference for selecting Eastern European firms to do their

offshore work (Pierre Audoin Consultants (2003), quoted in Huws et. al. 2004).

Nevertheless, there is a sizable amount of work sent from Germany as well as from the

United Kingdom to India. Eurostat data (Community Labour Force Survey) shows that the

EU countries that are growing most rapidly in IT business activities are the new member

states such as Hungary which had been behind the rest of the EU in percentage of IT

activities. These data are consistent with, but not proof of, these countries becoming prime

destinations for European offshoring.

Table 2-2: The Extent and Impact of Offshoring on Europe

Forrester (August 2004 as

quoted in Gumbel 2004 and

Knapp 2004)

Jobs lost by Europe to offshoring by

2015

1.2 million,

including

150,000 IT

jobs

Deloitte Research (quoted in

Matlack et al. 2004)

Financial-services and high-tech jobs

that will migrate from Europe to lowwage

countries by 2008

800,000

Heidrick and

Struggles/PeopleSoft (2004) as

reported in van Breek (2004)

CEOs of European companies who

reported offshoring work to low-cost

labor markets as a key business issue

31%

European Commission 2000 (as

quoted in Huws et al. 2004)

European companies offshoring 5.3%

Forrester Research (as quoted in

Huws et al. 2004)

Value of offshore spending in western

Europe in 2004 and 2009

1.1 billion, 3.6

billion Euros

Gartner (as quoted in Huws et

al. 2004)

European business expected to

include offshoring in their business

plans by end of 2005

30%

Huws et al. (2004) EU service employment lost to

offshoring by 2015

2% to 3%

UNITED KINGDOM

The United Kingdom is the largest offshorer in Europe by a considerable margin, and this

trend is likely to continue at least for the next few years. Forrester Research estimates that

the United Kingdom will be responsible for three-quarters of all European offshoring in five

years (Huws et. al. 2004). 61% of UK companies send IT work across national boundaries

compared to only 15% in Germany, the second largest offshorer in Europe (Roland Berger

2004). Amicus (2004) claims that a thousand UK jobs are being lost to offshoring each

week and projects a loss of 200,000 UK IT jobs by 2008 with a significant number of these

positions in IT support.[BSB5] Management Consultancies Association predicts 25% growth

in offshoring of call centers between 2003 and 2008 (Huws et. al. 2004). The

Communications Workers Union (2004) predicts almost 200,000 call center jobs moved

from the United Kingdom to low-cost countries between 2004 and 2006.

According to the consulting firm Evalueserve (2004), the United Kingdom will face a

shortage of 714,000 workers by 2010 due to the aging of the workforce. IT is one of the

fields projected to have the greatest shortages. Evalueserve estimates that 342,000 of

these 714,000 jobs can be filled by immigrants and notes that the remainder will need to be

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filled in other ways if the country is to avoid a decline in GDP due to an insufficient labor

pool. Evalueserve claims that, by the end of 2002, 31,100 jobs in the service sector in the

United Kingdom had been moved offshore, and the company projects that 272,000 more

jobs will move offshore in the period 2003-2010. Focusing more narrowly on IT and

software development jobs only, Evalueserve claims that 18,000 jobs had been moved

offshore by the end of 2002 and 84,000 more would be moved between 2003 and 2010.

GERMANY

In Germany, there are no federal statistics that help to track the number of jobs offshored

(Bartsch 2004). For various reasons, it is expected that offshoring will not be as significant

in Germany as in the United States: few people in low-wage countries speak German,

Germany has fewer low-skill jobs than the United States of the sort that have been

offshored, stricter layoff regulations make it more costly in Germany than in the United

States to lay off workers and relocate the work overseas, and there has been less political

fallout over jobless recovery after the last recession than in the United States. Germany

historically does not have such strong labor rebounds after a recession as the United States.

After the most recent recession, job recovery was close to the historical norms in Germany,

while in the United States the recovery led to an unprecedented small number of jobs

created.

Using an analysis of German foreign direct investment in Central and Eastern Europe by

the Oesteuropa-Institut, together with employment trends in German foreign affiliates and

correction factors for the German foreign affiliates numbers (because they underreport

activities by small and medium-sized companies), Elga Bartsch arrived at an estimate on

behalf of the consulting firm Morgan Stanley that the number of jobs (of all kinds) offshored

to Central and Eastern Europe over the past decade is approximately 600,000. She also

considered an alternate source, the European Restructuring Monitor (ERM), which “compiles

information on major corporate restructuring announcements from daily press runs of the

major national newspapers in the European Union and classifies them by country, industry,

and reason for the restructuring” (Bartsch 2004). The ERM found that 117,000 jobs losses

were announced in Germany from January 2002 into mid-2004, and that 3% were lost to

relocation of production facilities and another 0.3% to outsourcing. In another study

commissioned by the Deutsche Bank, it was estimated that 50,000 German IT-related jobs

had been relocated outside Germany up until the time of the publication of the study (Huws

and Flecker 2004).

In a McKinsey study (Farrell 2004), Germany shows only a $0.80 return on each dollar

invested in offshoring, compared to $1.14 return on the dollar invested in offshoring for the

United States. There are multiple reasons for this: German companies have higher

management costs because of language and cultural issues; offshoring work is frequently

contracted to Eastern Europe where the wages and infrastructure costs are higher than in

India; Germany is not able to capture much in high-tech exports through offshoring because

of the dominance of US firms in these export markets; Germany gains practically nothing

from repatriated earnings (i.e., from offshoring providers abroad that German companies

have invested in); and most important of all, as many as 60% of German workers have

difficulty being re-employed when they lose their jobs through offshoring which is a major

drag on the German economy.

What Does the Data Tell Us About the Size and Impact of Offshoring in India?

By far, the most complete data about the Indian software industry is provided by the

Indian trade association, NASSCOM. Table 3 provides a snapshot of the offshore industry

based on the NASSCOM Strategic Review 2005. You can see that the industry is vibrant

with growth in the 20 to 30 percent range each year. IT software and services are still the

largest export, far ahead of hardware and ITES/BPO, but the IT-enabled services are

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growing more rapidly than any other sector of the Indian offshoring industry. The United

States, followed distantly by the United Kingdom, is the destination of most of this work.3

About 60% of the ITES/BPO work is conducted by multinationals with this percentage

edging higher over time. The export trade is growing much more rapidly than the domestic

IT/ITES market in India, from 58% to 78% by revenue from 1996 to 2003 (RIS 2004 as

quoted in UNCTAD 2004). The software and service industry is becoming increasingly

important to India’s economy, growing from 3% to 21% of India’s total exports between

1996 and 2003 (RIS 2004 as quoted in UNCTAD 2004). Although there are more than 3000

software and service exporters in India, 25 of these firms collect more than 60% of the

revenue (Prism 2004).

Table 2-3: The Extent and Impact of Offshoring in India

Indian national economic output attributable to the ITITES

industry in 1997-98

1.2%

Indian national economic output attributable to the ITITES

industry in 2003-04

3.5%

Indian IT industry revenue in IT services and software in

2003-04

60%

Indian IT industry in hardware in 2003-04 22%

Indian IT industry in ITES/BPO in 2003-04 18%

Growth in Indian IT and ITES exports $9.9 billion in 2002-03

$$13.3 billion in 2003-04

IT and ITES export from India to the United States in

2003-04

69%

IT and ITES export from India to Europe in 2003-04 22% (mostly to the United

Kingdom)

India IT services and software revenue in 2003-04 $12.8 billion (29.6% increase

over previous year)

Jobs added to Indian IT services and software sector in

2003-04

98,000 (more to domestic

companies than multinationals)

Growth in Indian IT services revenue $1.9 billion in 2002-03

$2.5 billion in 2003-04

Growth in Indian offshore product development exports

(includes exports of software products made by Indian

companies)

$560 million in 2002-03

$710 million in 2003-04

(mostly produced by

multinational captives)

Multinational companies that opened captive centers in

India since early 2001

230

3 Joseph and Parayil (2004 as quoted in UNCTAD 2004) claims 80%. Table 3 gives 69% for IT and

ITES combined.

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Value of research conducted by Indian captives of

multinationals in 2003-04

$800 million to $1 billion

Value of research conducted by Indian captives of

multinationals in 2008 (projected)

$11 billion

Call center seats 96,000 in 2003; 158,000 in

2004

Source: NASSCOM Strategic Review 2005

What Does the Data Tell Us About the Size and Impact of Offshoring in Countries Other

Than India That Do Software Work for Export?

Quantitative information about software exports especially those related to offshoring is

difficult to locate for most countries. Table 4 provides a smattering of data that we have

been able to locate although we cannot attest to its correctness.

Table 2-4: Nations Other than India with Offshoring Industries

Country Statistic Source

Australia $21B commercial service exports in

2003

(22% computer and communications)

World Development Index database

call center seats: 135,000 in 2003,

146,000 in 2004

www.bpoindria.org/knowledgeBase/

Barbados $1.1B commercial service exports in

2003

(16% computer and communications)

World Development Index database

Belarus $1.5B commercial service

exports in 2003

(24% computer and communications)

World Development Index database

Brazil $9.6B commercial service exports in

2003

(50% computer and communications)

World Development Index database

Canada HRDC estimates 500,000 Canadians

work in call centers

Prism (2004)

Cape Verde

Islands

$211M commercial service exports in

2003

(9% computer and communications)

World Development Index database

China 8,000 software and service providers,

_ of whom have fewer than 50

employees and only five have more

than 2,000 employees. (Yuan 2005)

McKinsey (January 2005)

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$1.5B in 2003 Prism (2004)

Call center seats: 38,000 in 2003;

54,000 in 2004

www.bpoindria.org/knowledgeBase/

Czech

Republic

$7.8B commercial service exports in

2003

(24% computer and communications)

World Development Index database

Dominican

Republic

$3.4B commercial service exports in

2003

(5% computer and communications)

World Development Index database

Ghana $612M commercial service exports in

2003

(11% computer and communications)

World Development Index database

Guatemala $954M commercial service exports in

2003

(19% computer and communications)

World Development Index database

Hong Kong Call center seats: 10,000 in 2003;

10,700 in 2004

www.bpoindria.org/knowledgeBase/

Hungary $7.9B commercial service exports in

2003

(41% computer and communications)

World Development Index database

Ireland leads the global market in offshore IT

services with 25% of market

World Investment Report 2004

$3.8B in 2000, 8.5B Euros in 2003 Prism

60% of EU software is developed or

localized in Ireland; software industry

is 11% of GDP

55% of Ireland’s 28,000 IT

professionals are employed by

multinationals and account for 90%

of Irish software exports

$38B commercial service exports in

2003

(61% computer and communications)

World Development Index database

Israel $1.9B value in offshoring exports in

2002

Prism (2004)

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Latvia $1.5B commercial service exports in

2003

(19% in computer and

communications)

World Development Index database

Madagascar $202M commercial service exports in

2003

(32% computer and communications)

World Development Index database

Malaysia call centers growing at between 100

and 200% per year since 2000

World Investment Report 2004

$14B commercial service exports in

2003

(33% computer and communications)

World Development Index database

Mauritius $1.3B commercial service exports in

2003

(17% computer and communications)

World Development Index database

Mexico $13B commercial service exports in

2003

(7% computer and communications)

World Development Index database

Morocco $5.1B commercial service exports in

2003

(18% computer and communications)

World Development Index database

Call center seats in all North Africa in

2005 (Morocco has largest share):

3,900

Datamonitor

New Zealand Call center seats: 12,000 in 2003;

13,500 in 2004

www.bpoindria.org/knowledgeBase/

Philippines 27,000 people in call center jobs in

2003 and growing rapidly

World Investment Report 2004

$250 software, or $1B including BPO

(2003)

Prism (2004)

Call center seats: 20,000 in 2003;

40,000 in 2004

www.bpoindria.org/knowledgeBase/

Poland number of jobs in BPO will increase

from 3,000 in 2004 to 200,000 in

2008

McKinsey & Co. (as quoted in

Wagstyl 2004)

Romania $3B commercial service exports in

2003

(42% computer and communications)

World Development Index database

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Russia $150 – 200M value of offshoring

exportsin 2003

Prism (2004)

Senegal $3890M commercial service exports

in 2002

(40% computer and communications)

World Development Index database

Singapore Call center seats: 10,000 in 2003;

10,100 in 2004

www.bpoindria.org/knowledgeBase/

Slovak

Republic

$3.3B commercial service exports in

2003

(28% computer and communications)

World Development Index database

South Africa number of call centers to expand

from 494 in 2004 to 939 in 2008);

serving the English but also the

German populations.

Datamonitor (as quoted in

Chatterjee 2004)

Employees working in call centers in

2005

New York Times (Feb 2, 2005)

$6.4B commercial service export in

2003

(9% computer and communications)

World Development Index database

Thailand Call center seats: 11,000 in 2003;

13,000 in 2004

www.bpoindria.org/knowledgeBase/

Tunisia $2.8B commercial service exports in

2003

(16% computer and communications)

World Development Index database

Ukraine $5B commercial service exports in

2003

(11% computer and communications)

World Development Index database

2.3 Conclusions

Even in the face of offshoring, economists generally continue to believe in the theory of

comparative advantage, that if each country specializes in the production of goods where it

has comparative advantage and trade is not restricted, both countries can enjoy greater

total consumption and well being by trading with one another. Some economists, notably

Gomory and Baumol, have pointed out that it is possible for a country to lose under free

trade. In the short-term, the question is one of jobs and wages. Are the jobs lost to

offshoring in developed countries compensated for by new job creation in these countries

which might come, for example, from the lower cost of development and production, faster

development time, higher quality, or round-the-clock service associated with using an

offshore workforce to supplement or supplant the domestic workforce? Similar questions

can be asked about wage rates. The analysis by Mann of hardware offshoring to Asia in the

1990s suggests by analogy that it is entirely possible for a developed nation to be much

better off through offshoring of its software work. Recent Bureau of Labor Statistics shows

that IT jobs and wages have generally increased in the United States from the height of the

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dot-com boom until late 2003, a period during which there was active offshoring. However,

lack of data limits what we can say about the impact of offshoring.

Leaving aside for the moment the question of whether offshoring has hurt aggregate jobs

or wages, there are at least two ways in which offshoring might harm a developed country.

Offshoring clearly can do harm to individuals who lose their jobs through offhsoring and to

local communities that lose large numbers of jobs or particular businesses through this type

of trade. The general sense among economists is that the only solution to this is a political

one of providing a safety net to workers. This might include wage insurance, extended

unemployment benefits, retraining, and perhaps others benefits. However, the costs of

providing this safety net are great. The other way that offshoring can harm a developed

country in the long run is to erode the country’s capability to innovate. As a developed

country loses its edge in innovation, it becomes less able to remain competitive. Enabling a

country to remain innovative is a matter of education, research funding, and immigration

policy. These issues are discussed in Chapters 7 and 8.

What does the available data tell us about the extent and trajectories of offshoring? First,

considering the United States which has seen the largest amount of offshoring and is

subject to the greatest amount of loss through offshoring, we know that there are perhaps

12 to 14 million jobs vulnerable to offshoring. However, this number represents a high

upper bound on potential job losses, and nobody believes that all these jobs will be lost. So

far, annual job losses have probably been no more than 2 to 3% of the IT workforce in the

United States. Moreover, there are questions about the reliability of these numbers because

of the definitions and other methodological issues. The meaningfulness is also at question

because these job losses have to be placed in perspective with the much higher level of job

loss and creation that occurs every year in the United States and, in particular, with the jobs

that are created directly or indirectly because of companies sending work offshore. The

data simply does not exist that would enable a full analysis of the impact of offshoring on

the US IT workforce. Anecdotal information, together with data, suggest that the United

States will continue to increase the amount of work it offshores at double-digit percentage

rates at least for the next few years. Programming and related technical work continues to

be the work most likely to be offshored, but IT-enabled services are rapidly taking a greater

share. There is also rapid growth, from a small base, in the offshoring of higher-value

activities such as knowledge processing and research.

Data about countries other than the United States or worldwide data are much harder to

come by than data for the United States. There are reports of offshoring industries or

sectors of these industries that have grown in India, China, and a few other countries by 20,

30, or higher percentages per year with projections that these growth rates will continue for

varying lengths of time into the future. It is difficult to evaluate these projections but it

seems likely that there will be continued rapid growth at least for the next few years.

Whether these growth rates will be 10, 20, 30, or 40 percent per year is beyond our ability

to project based on existing data. It appears that India will continue to be the primary

destination of offshoring, with China growing rapidly. However, Chinese software activities

are devoted to a significant extent on the emerging domestic market not the export market.

There appears to be some promise of growth for the main nearsourcing countries such as

Canada and those in Eastern Europe despite the fact that their wage rates are higher than

those in the low-wage Asian countries. There are at least limited opportunities for

offshoring work by companies located in Africa, Latin America, and low-wage Asian

countries other than India and China. Data, together with anecdotal evidence, suggests that

Western Europe is beginning to increase the amount of work it offshores. The United

Kingdom has been by far the largest offshorer in Europe, and this is likely to continue to be

true for the next few years. And Germany, in particular, has begun to increase the amount

Page 96

of work being offshored in the past year or two. Japan is set to increase the amount of

work offshored especially to China.

There are numerous problems with the current state of data. Definitions used in reporting

offshoring’s growth and impact are inconsistent with one another. All of the obvious metrics

that could be used to measure offshoring have limitations. Government statistical

organizations, such as the US Bureau of Labor Statistics and the Bureau of Economic

Analysis, provide the greatest promise in providing good data because of their highly trained

staffs and long traditions of quality, reliability, and objectivity. Governments collect data,

however, in connection with existing policy issues, and the offshoring phenomena is

sufficiently different that existing government data sources turn out to be not very useful.

Trade organizations and consulting firms are not disinterested parties, and these

organizations are often unwilling to make public the methods and assumptions by which

they arrive at their results so it is not surprising that there is some skepticism in the

economic community about the credibility of their results. For many parts of the world,

little or no data is being gathered.

A professional society such as ACM itself is not in a good position to collect data.

However, it can encourage the principal data gatherers – governments, trade associations,

and consultants – to improve their offshoring data practices. We need clear definitions,

careful choice of metrics, data that separates the impact of offshoring on job loss from other

causes of job loss such as business cycles and technological change, and data that

measures the various aspects of offshoring (jobs created, gains in wealth to companies and

nations, impact on wage rates, etc.) not just job loss. Thus, we recommend that the

following steps be taken:

Standard definitions of offshoring and related terms should be developed. A good starting

place is the diagram developed by the US General Accountability Office (Figure 2) that

provides a complete description of all outsourcing and offshoring activities. These definitions

should be used by all countries participating in the global software market, not just the

United States.

The US Department of Labor should gather data on layoffs that is more suited to

measuring offshoring than the current Mass Layoffs Statistics data. Ideally, such data

should be collected on a regular basis, but even a one-time special effort would be useful.

Other countries should collect similar data.

The United States should improve the collection of data on imports and exports of

services by country, following the guidelines recommended by the General Accounting Office

(2004). Other countries should follow similar practices, and practices should be consistent

from country to country.

Data on direct investment abroad by source country and multinational company

operations should be improved also following the recommendations of the GAO (2004).

R&D and design activities in low-wage countries should be tracked especially in affiliates

of multinational firms.

All organizations, private as well as public, that are creating statistical information about

offshoring should be transparent about their methods and assumptions.

Developing better current data and adopting standardized definitions should help to

improve projections of offshoring. We are not sanguine, however, about the likelihood of

developing good projections any time soon. In the United States, the BLS has been

modestly successful in developing ten-year occupational projections, but projecting the size

and effects of offshoring appears to be more difficult.

Page 97

Figure 2-2

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Page 100

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Economists Supporting Globalization. Journal of Economic Perspectives 18, 3, 135-136.

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from Offshore BPO Exports in 2007. Gartner Dataquest Report (June) Stamford, CT.

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Evidence from the Second Industrial Revolution. UCLA, Department of Economics. Working

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Service Functions: The Next Global Shift? World Investment Report 2004 (Chapter 4).

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Data Provide Limited Insight into Offshoring of Services. GAO-04-932, (Sept.).

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2005. (Online publicity for The Conference Board, Report 1353-04-RR. CEO Challenge

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*M. Blasgen and M. Kenney took a leadership position in the writing of Chapter 3. Page 101

Authors: Govindasamy Balatchandirane, Michael Blasgen*, Arndt Bode, Charles H. House,

Martin Kenney*, Vivek Mansingh, Goran Marklund, Bankim Shah, Takashi Umezawa

Chapter 3: The Country Perspective

3.1 Introduction

This chapter examines the development and current status of the largest and most

dynamic nations in the evolving global software market with particular attention given to

offshoring. The focus is on software services and to a lesser extent on software products. In

particular, the chapter examines three pairs of regions that have special offshoring

relationships with one another: the United States and India, Japan and China, and Western

Europe and Eastern Europe/Russia. The selection of these three pairs is not meant to argue

that there are not other linkages, for example, between Western Europe and India; there

are. Western Europe is not monolithic in its offshoring patterns; it has different

geographical patterns, largely based on language capabilities. For example, the United

Kingdom sends its offshore work primarily to India, whereas Germany has strong

relationships with both Eastern Europe/Russia and India (see Figure 1). Thus the portrayal

here of national/regional pairs of offshoring partners, while representing some important

aspects of the global software industry, is clearly a simplification of an extremely

complicated map of offshoring.

Figure 3-1. Outsourcing from Germany

Source: Compilation from various newspaper articles by Martin Wildemann 2005:19

The decision to focus on only these regions and nations means that we omit some

countries that are active in the global trade in software. In particular, we touch only briefly

on Ireland and Israel who were among the earliest countries to enter the global market.

8

%

23%

7

%

15%

15%

21%

9

%

Other 1%

Western

Europe

Eastern Europe

(in EU)

Eastern Europe (not

in EU) Asia (except China

and India)

Page 102

Although their software export markets are significant, they are relatively small and are not

expected to grow much especially in comparison, for instance, to India or China. Ireland

and Israel also do not appear to have a major effect on the global division of software labor.

We also omit many nations that have smaller software services export businesses such as

the Philippines and Mexico. Mexico, which in 2003 is estimated to have exported $30

million of software and software services (Singh 2003), is discussed in Chapter 4 through an

examination of one of its leading software export firms, Softtek. Mexico’s limited amount of

software services exports is typical of many developing nations. Rather than listing all of the

nations and the size of their industries (see some data on this topic in Chapter 2), this

chapter focuses on the most important ones, but suggests that they are not unusual, just

indicative of the larger pattern of globalization.

Offshoring has a long history and continues to evolve. National IT industries and

international supplier-customer relationships are part of a co-evolutionary process involving

many parties. Factors include government support, education, infrastructure,

telecommunications policy, finance, and even national perceptions. These factors interact

and gradually produce an environment more or less favorable to accepting relocated work.

This is exemplified in the case of China and its manufacturing sector where a sophisticated

manufacturing support infrastructure evolved over the past two decades to facilitate the

manufacturing of goods for export. In the case of India, higher educational institutions,

infrastructure, labor force, and government policies have evolved in a way that encourage

and support the production of IT services for the global economy. Each of the nations and

international relationships examined in this section is a product of similar co-evolution.

For firms, the decision of whether and where to offshore a certain business function

involves a complex calculation that balances a variety of concerns that include labor force

availability, government policy, factor costs, various kinds of risk, and comfort level with the

location. For each of these nations, this chapter examines both their past experiences with

offshoring and their current situation. We also consider their prospects for future growth.

3.2 The History of Software Offshoring

The origins of software offshoring are difficult to determine because large multinationals

such as IBM have long had overseas R&D facilities that were conducting software

development for the company’s global operations at the same time that they were

undertaking localization work for their domestic markets. The nations that first emerged as

software development sites for the global economy, that is, not for the domestic market,

were Israel and Ireland. Notice the distinction made here between undertaking software

development for the domestic market, which includes localization and even some

development based on unique features of the local market such as different accounting or

legal systems, as opposed to producing for the external market. Production for the local

market can displace jobs for workers in high-wage countries. However, it is unremarkable

that localization would be undertaken in the local market where knowledge of the language

and the specifics of the business culture and legal environment are the greatest. With

respect to job loss, there is far greater concern about the displacement of labor by a nation

producing for another nation’s market than for its own.

The United States is the overwhelming leader in the world software industry as the home

to such firms as Accenture, IBM, Microsoft, and Oracle. The only firms that rival these giants

are SAP (headquartered in Germany) in packaged software and Siemens Business Systems

(Germany) and Cap Gemini (France) in software services. Siemens Business Systems is

losing money and may be sold.

Page 103

Let us turn briefly to the small economies, Ireland and Israel, which pioneered software

and software services production for the global economy. The Israeli IT industry first

emerged in the late 1960s through an excellent educational system, military research, a

strong relationship to the United States based on geopolitics, and investment by

multinationals (de Fontenay and Carmel 2004). In the 1980s, Israelis began to found new

technology firms, many of which specialized in packaged software especially for security.

These Israeli firms often had cutting-edge technologies and, as part of their life cycle, very

soon established operations in the United States. The most successful of them listed their

stock on NASDAQ. Many of these firms were successful, but because of the small size of the

Israeli software industry their success is unlikely to lead to a massive relocation of

employment from the developed nations to Israel. The total Israeli employment in IT

services, including software, was 92,000 in 2000 or approximately 4 percent of the total

Israeli workforce (de Fontenay and Carmel 2004, 43). The Israeli Export and International

Cooperation Institute (2005) reports Israel as having 13,000 software professionals in 2002,

down from an all-time high of 14,500 in 2000. Whichever number is correct, Israel has a

much smaller software workforce than larger nations, though it is unusually large in terms

of the percentage of its own population. Even if Israel were to double its IT services

employment to an unheard of 8 percent of its workforce – amounting to some 200,000

employees – it would still be less than one-third the size of India’s 697,000 employees in

software and software-related services. Israel’s niche in the global software industry is as a

center of entrepreneurship at the highest technological level. It draws upon the technical

expertise of a highly trained workforce, and its startups almost immediately enter the US

market by forming an offshore office.

Another early location for software offshoring was Ireland. In the 1990s, both Irish

indigenous firms and multinationals rapidly increased their software-related activities in

Ireland. For the multinationals, Ireland was a convenient low-cost, English-speaking nation

that had strong European language skills. The multinationals adopted Ireland as an offshore

platform for Europe. In 2000, the total number of employees in the Irish software and

computer services firms, counting both indigenous and multinational firms, was 30,000

(Arora et. al. 2004). It is difficult to fully reconcile the various statistics as O’Riain (2004)

believes that in 1999 there were over 50,000 employed in the software industry. The larger

number may be misleading because O’Riain finds that the multinational firms that make up

approximately two-thirds of total software industry employment include among their

activities disk reproduction, packaging, language localization for Europe, and porting

(O’Riain 2004).

Ireland’s software industry includes two kinds of companies. There are some indigenous

firms that produce packaged products, although they have not been as successful as the

strongest Israeli firms. Ireland is also a packaging and localization platform for foreign,

particularly US, multinationals supplying the European market. Ireland has experienced

robust growth in its software industry but, like Israel, the global impact has been limited.

Recently, the Irish press has expressed concern that India might be a threat to the growth

of the employment in the Irish software industry (Weckler 2004).

Israel and Ireland were pioneers in entering the global software business without a

significant home market. Israel’s entry was at the high end of the industry, both in terms of

multinationals operating there and the local entrepreneurship. Because Israeli firms quickly

built strong business units in the United States, they are often treated as being the same as

US firms. In fact, the growth of a successful Israeli firm often occurs as much in the United

States as in Israel. In the Irish software industry, startups have produced software for the

world market but they typically remain small players, while multinationals located there are

fixed on one aspect of the global market, meeting the multinational’s localization needs for

Page 104

the European market. The software industry is a significant economic contributor to Ireland

even though it remains quite small in global terms.

Due to their small size and strong relationships with the rest of the developed world, the

Israeli and Irish software industries were successful without disrupting the software

industries in other nations. Wages in Israel and Ireland were slightly lower than the markets

they serviced, primarily the United States and Europe. Israel competed not on cost, but

instead on the high quality of its workforce. Ireland had a wage advantage and special

subsidies from the European Union but operated on only a small scale. What these two

countries showed was that a nation that did not have a large local market could

nevertheless perform software work at a distance from the final market if it had a skilled

workforce and access to good telecommunications infrastructure.

The next set of entrants could disrupt existing software industries. The largest and most

sophisticated of these national entrants was India. By the late 1990s, software

programming was no longer a skill that was highly concentrated in the developing nations.

People in low-income nations could afford an increasingly powerful personal computer and

had access to inexpensive, high-capacity data communications networks. Not surprisingly,

these countries could and did begin offering programming services in the global economy.

Today, it is possible to benefit from labor cost savings for programming services from a

large number of developing nations. Although the pattern is peppered with many

exceptions, there is a global division of labor emerging with India serving the Englishlanguage

market, Eastern Europe and Russia serving Western Europe, and China serving

Japan. Developing nations around the world have been eager to capture the wealth and jobs

associated with software offshoring.

From the inception of the computer industry in the 1950s, the United States was not only

the leading center for software but also defined the global software environment because of

its technology leadership, enormous market, and massive investment in IT R&D. Other

national markets were, for all intents and purposes, local markets having their own software

firms that were always under threat from being submerged by global firms. If local firms

wanted to expand significantly, then the US market was critical to their success. This was

something the Israeli firms understood from their inception. For this reason, the first two

nations to be discussed are the United States and its principal offshoring destination, India.

3.3 The United States

US-based companies continue to dominate the software and services industry. Of the

roughly $285 billion in total revenues of the global industry in 2004, only about $50 billion

was generated by non-US companies.1 2

History of the US Software and Software Services Industry

From the inception of the modern computer industry, the United States has been the

leader in both the hardware and software industries. The United States has also been the

source of many of the software standards such as Windows, Microsoft Office, and Unix,

1 This was calculated from the 2004 SoftwareMag.com Global Software 500 ranking.

2 This accounts for only the traded software and software services. So, for example, if a firm writes

software internally for only Internal use, then this is not included because it is untraded. This is an

enormous category and is likely to be even greater than the amount traded. Chapter 4 examines

firms that have large internal software operations whose work is being offshored even though it is not

traded.

Page 105

providing US firms with an important first-mover advantage.3 Although today some might

dispute US leadership in hardware due to the growth of East Asian producers, few would

dispute US leadership in software and software services. Software and software services as

an independent business has been practiced in the United States for more than fifty years,

since the founding of the computer services firm Automatic Data Processing (ADP) in 1949.

Computer Usage Corporation (CUC), founded in 1955, was the first company formed

specifically to provide software development services to computer users. Its first project

was a program written for a customer to simulate the flow of oil. Computer Sciences

Corporation (CSC), founded in 1959, is now a $10 billion company. EDS, one of the most

important computer services firms, was founded in 1962. Since then, thousands of

companies that provide software and software services have been formed.

The growth of independent software and services firms was assisted by the decision by

IBM in 1969 to unbundle its application software and tools from its hardware. IBM did not

unbundle its operating systems from the hardware; the control system was included in

every product IBM sold for many years after 1969. By 1969, there were already

approximately 2,800 independent software product and services firms, and they had

combined revenue of $600 million (Steinmueller 1996). At the same time the software and

software services industry was emerging, large firms, especially in the financial and defense

sectors of the economy, were introducing computers into their operations and building

internal software competencies. For most firms, the building of internal IT expertise was

both a potential competitive advantage and a necessity because computers were becoming

key devices for managing the increasingly complex corporate operations they made

possible. By the end of the 1960s, the combination of government funding of engineering

and computer science research in the open university environment, early adoption by

sophisticated lead users, and the United States’ role as the largest economy and market in

the world meant that the United States gained what appeared to be an insurmountable lead

in the software arena.

The US software and services industry was affected by other developments as well.

Drops in prices of semiconductors and data storage, driven in part by Moore’s law, led to

continuous price-performance increases in computers. The big mainframe of the 1960s was

complemented by the arrival of the minicomputer in the 1970s and the personal computer

in the early 1980s. The PC drove the cost of a computer down to a level that permitted an

installed base of millions of computers, not the hundreds of computers of the 1950s or the

thousands of the 1960s. This growth in the installed base was accompanied by a huge

growth in the demand for packaged software for these computers. The early independent

software companies developed applications and later computer tools. Originally the

operating system software was provided by the hardware vendors (IBM, Digital Equipment,

and others), but in recent years, independent software houses have emerged that also

develop operating systems. (For a discussion, see Baldwin and Clark 2000).

The introduction of a commoditized personal computer in the 1980s and the spread of the

Internet in the mid-1990s led to the creation of many new US companies, not only

companies such as Netscape, providing software to facilitate the use of the Internet, but

also the service and shopping companies such as Yahoo! and Priceline.com. The market

leaders, for instance, Google, Yahoo, Amazon, and eBay, weathered the dot-com stock

collapse beginning in 2000, and, in the process, they have transformed the way business is

conducted.

3 It is possible that the relative strength of US firms might eventually be eroded by widespread

adoption of open source software.

Page 106

US firms benefited the most from the new business models and software that drove the

Internet, and these firms continue to be globally dominant. They were created from the

research and private sector capabilities that were uniquely resident in the United States

(Kenney 2003). The dot-com crash led to severe employment loss in the IT/software sector.

It was also a watershed event for the global software industry. During the height of the

boom, US companies could not find enough US workers and sought extra capacity from

overseas, especially Indian workers (both imported to work in the United States and

working in India). After the crash, the role of the Indian workers was more as a

replacement than a supplement to US workers. The Internet has also contributed to

creating a more global labor market, making it easier to access technical talent in any

location with good telecommunications linkages.

The Current Situation for US Companies in Software and Services

As mentioned earlier, US firms receive about 80% of the revenue available in software

and services. Of the top fifteen firms in this industry, only four – SAP (Germany), Hitachi

(Japan), CapGemini (France), and NTT (Japan) - are not from the United States, and these

firms occupy the bottom rungs of the top 15.

In 2004, US firms made up 16 of the top 20 packaged software firms when measured by

revenue. All of these firms have factories, development labs, and sales scattered across the

globe. But where is the employment? Of the approximately 595,000 workers in packaged

software, the United States employs 50 percent of the total global employment, while US

firms sell 84 percent of the packaged software purchased globally (McKinsey Global Institute

2005).

US firms have been remarkably successful. For example, Microsoft’s fiscal year 2005

profits of over $12 billion were comparable to the $12 billion in fiscal year 2005 revenue of

the entire Indian software and services export industry. Microsoft’s profit was also

approximately equal to the sales of the largest European firm, SAP. IBM’s software and

services revenues in 2004 were in excess of $61 billion. The point is that US packaged

software firms, by any measure, are still globally dominant. In terms of influence, the

importance of this dominance is even greater than simply sales; the United States is the

global hotspot for packaged software.

The McKinsey Global Institute (2005) reports that US jobs in the packaged software

industry are at risk of being offshored. McKinsey finds that 60 to 78 percent of the jobs at

risk are professional engineers and associated middle-level managers, that is, the heart of

the packaged software industry. Other occupational groups in the packaged software

industry have lesser but very significant numbers of jobs at risk. As shown in Table 2, it is

exactly in the more highly educated employment categories that US firms are recruiting

actively in India and, to a lesser degree, in China. Notice that the position announcements

are not confined to low-end college graduates but also include doctoral-level positions for

sophisticated development projects. The beginnings of this process can be seen in Table 1

which shows the number of employees the software and software services firms currently

have in India. In every case, these numbers are increasing at double-digit rates.

Page 107

Table 3-1: Indian Employment by Non-Indian Software and Software Services

Firms

Nationality

Services

only

Employment

in India

(date)

Global

Employment*

% in

India Locations

Oracle U.S. 6,900 (2004) 41,658 16.6 Bangalore,

Hyderabad

Microsoft U.S. 1,250 (2004) 57,000 2.2 Bangalore,

Hyderabad

SAP Germany 2,000 (2005) 38,802 5.2 Bangalore

IBM4 U.S. 23,000

(2005)

369,277 6.2 Bangalore,

Delhi**,

Kolkota,

Pune,

Hyderabad

HP U.S. Yes 15,000

(2004)

150,000 10 Bangalore

Veritas U.S. 900 (2004) 17,250 5.2 Pune

Adobe U.S. 500 (2005) 3,142 15.9 Delhi

Symantec U.S. 0 (2005) 5,300 0 n/a

EDS U.S. Yes 2,400 (2004) 117,000 2.1 Chennai,

Delhi,

Mumbai,

Pune

Dassault

Sys

France 0 4,088 0 n/a

Cap

Gemini

France Yes 2,000 (2004) 59,324 3.4 Mumbai,

Bangalore

Siemens

Bus Sys

Germany Yes 4,000 (2004) 36,000 11.1 Bangalore

Getronics Netherlands Yes n/a 28,000

Atos-Origin France Yes 750 (2004) 46,583 1.5 Mumbai

Tietoenator Finland Yes 120 (2005) 14,000 .9 Pune

* Hoover’s 2004

**Delhi includes Noida and Gurgaon which are suburbs in other states

All bolded firms include large non-software based employment

Source: Internet searches

4 This includes the 6,000 BPO employees when IBM acquired Daksh and also includes those working

for the domestic market.

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The United States leads in software services as well as in packaged software, and this

lead in services is also attributable in part to the early software development in the United

States. The United States is the largest single software services market in the world,

accounting for approximately 41 percent ($198.6 billion) of a total 2004 global market of

$484.3 billion (McKinsey Global Institute 2005). US vendors are the global leaders in the

global software services industry (11 of the Top 20 globally are headquartered in the United

States) with IBM Global Services at 2004 sales of $46 billion by far the largest. Software

services employment in the United States is approximately 1.7 million, of which 42 percent

are engineers (McKinsey Global Institute 2005). In other words, software services is a large

industry and the United States supplies about 32 percent of the total global workforce

(McKinsey Global Institute 2005: 158).

The occupational categories in IT services that McKinsey finds most amenable to

offshoring are software and hardware engineers and associated middle-level managers, of

which 47 to 56 percent could be offshored. Analysts working on software/IT architecture or

market research are similarly vulnerable (45 to 55 percent). It is in software services

where the most aggressive competition from Indian vendors is to be found, and where the

US leaders, such as IBM, Accenture, and Hewlett Packard, are rapidly increasing their

offshore and particularly Indian presence.

One can expect the number of available jobs, job tenure, and wages throughout the

software and service-related industries to be pressured by offshoring during the next

decade. This pressure will also be felt in the internal IT shops across all industries as

management considers options ranging from establishing offshore subsidiaries to

outsourcing the work to either a US firm operating abroad or an Indian firm. Routine

software production and services work appears to be increasingly susceptible to offshoring.

Conclusion on the United States

During the past five decades the dominance of the US industry has been a given. What is

changing is where the work will be undertaken. What has been an enormous export to the

world and a well-paid source of employment for technically well-trained Americans is now in

question as sufficiently well-trained individuals in much lower-wage nations are becoming

participants in the global economy and will be competing for those jobs. As Chapter 7 on

education discusses in greater detail, the US higher education system will have to address

the question of what their students should learn to prepare for these changes. At the

national level, there has been a dramatic underinvestment in engineering education and

research over the last two decades,5 and the recent decisions by the federal government to

reallocate research funds from universities to industry will further weaken engineering. This

is likely to contribute to an erosion of the cutting-edge research that makes the United

States a desirable place to undertake software innovation and development and which has

made the US high-technology industry a global leader.

3.4 India6

Software services have become India’s largest export, and the emergence of India as a

source of software service exports is attracting great attention in the developed world. India

has only recently attracted attention for its software service exports despite the fact that

5 For example, since 1970, U.S. federal spending in physical science research declined as a percentage

of Gross Domestic Product - an indicator as the rate of investment relative to

growth in the economy - from just under 1% of GPD to .5% in 2004.

Source: http://www.aaas.org/spp/rd/disc04tb.pdf

6 This section draws heavily upon Dossani (forthcoming 2006).

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the industry has grown relatively steadily for three decades. Employment reached 697,000

(approximately 50% working for the domestic market) at the end of March 2005 (see Figure

2), a growth of 19.8 percent from the year earlier (Nasscom 2005). If the industry grows at

20 percent per year in 2005-2006, then the number of employees added in India would be

the equivalent of all the software workers in Ireland and Israel combined. India is emerging

as the single most important destination of software services offshoring.

Figure 3-2: Employment in the Indian Software Services and ITES-BPO Sector

Source: NASSCOM

As a large developing nation, India has many shortcomings including high rates of

poverty, corruption, and illiteracy; a substandard infrastructure; excess government

regulation; and various other problems typical of a poor nation. These obstacles are offset

by a number of strengths especially for software and services production. It has a long

history of producing capable mathematicians. It has a large population with adequate

English language capability. There is a large cadre of Indian managerial and technical

professionals working in North American and, to a lesser degree, in European hightechnology

occupations and organizations. For those who can afford it, India has a strong

and highly competitive K-12 educational system emphasizing science and mathematics.

Although India has a democratic socialist tradition with high levels of bureaucracy and overregulation,

it does have a market economy. These are all advantage that India has over

China in establishing a software services industry.

History of IT in India

The roots of India’s entry into the global IT industry can be traced to its initial highly

protectionist regulatory environment (Heeks 1996). As in many other nations, India’s

national policymakers focused on manufacturing. Protected from the global market and with

a domestic orientation, Indian hardware producers never became global competitors.

Because US firms established facilities in East Asia and homegrown Japanese, Korean, and

Taiwanese firms became subcontractors and later producers, the IT hardware industry

became concentrated in East Asia. Eventually, Taiwan emerged as the center for PC

assembly and India became largely irrelevant for electronics manufacturing (Dedrick and

Kraemer 1998).

The Indian software industry was established to serve the local market. Prior to the

decision in 1969 by IBM to unbundle its software from its hardware that spurred the growth

of an independent software industry, the only private Indian software firm was Tata

Consultancy Services (TCS) which had been established in 1968 to serve the in-house data-

242

360

416

490

588

697

348

254

180

106

42 70

FY00 FY01 FY02 FY03 FY04 FY05

IT Software and Services

ITES-BPO

Employee numbers ‘000s

Page 110

processing needs of the Tata Group. Using a Burroughs mainframe, TCS began offering

electronic data processing services to outside clients and also became Burroughs’ exclusive

India sales agent in 1970. India’s first exports occurred in 1974 when Burroughs,

recognizing the competence and cost advantage of the TCS personnel, asked TCS to install

its system software at the offices of its US customers (Ramadorai 2003 quoted in Dossani

2006). Aware of the profitability of providing such contracts, other domestic firms were

formed to offer similar services. Sending these programmers overseas to work on the

client’s premises became a common phenomenon, and was pejoratively known as bodyshopping.

Factors Contributing to Bangalore, India as a Principal Site of Offshoring

Bangalore is considered by most observers to be the hub of the Indian IT

industry. In fact, the United Nations Human Development Report has ranked

Bangalore as a global hub of technological innovation. The city of Bangalore is the

largest employer of software professionals in India, employing about 160,000

people in the technology sector of which IT services accounts for 100,000

employees, with the remainder in business process outsourcing and call centers.

The general context. Bangalore has had a number of advantageous events, some

historical and some recent, that have contributed to the rapid development of its

IT industry. These include the IT boom of the 1990s and the subsequent world

demand for IT products and services, the rapidly falling price of hardware, the

technological progress that enabled ever larger volumes of data to be copied onto

disks of the same physical size, the explosion of the Internet and the rapid

reduction in costs of sending data, the liberalization of the Indian economy in the

1990s, and the Y2K problem which came at the right time and showed that Indian

IT professionals could deliver.

High-tech center. From 1945, when Nehru became the prime minister, Bangalore

was considered to be the science city of India. The state of Karnataka, of which

Bangalore is the capital, is home to a large number of engineering colleges that

provide a steady supply of highly educated, skilled workers for the IT industry.

Bangalore also is the home to a number of large public and private sector

organizations that employ many specialized skilled personnel working in high

technology occupations. Though these organizations, such as the Indian Space

Research Organization (ISRO), the Hindustan Aeronauticals Limited (HAL), Bharat

Electronics, and Indian Telecom industries (ITI), are located in Bangalore and

were important for creating the technology-oriented environment, they have not

provided large numbers of technical personnel to the IT industry (D’Costa and

Sridharan 2003). Among Indians, Bangalore has a reputation as the technology

capital, though other cities such as Pune and Hyderabad are intent upon

challenging this perception.

Local government policy incentives. Policy liberalization was the tool used by the

Karnataka state government to create the environment that facilitated the growth

of the software industry. In the early 1980s, state officials made their first move

which was to establish a Software Export Processing Zone in Bangalore. Since

then the state government has acted to promote the industry’s growth in many

ways such as providing preferential treatment on land allocation, provisioning

electrical supply, and (until recently) providing a better infrastructure than most

other Indian cities. These incentives reduced the costs of setting up and operating

an IT company. (See Chapter 8 and later in this chapter for a discussion of the

national policy environment.)

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national policy environment.)

Telecommunications infrastructure. Texas Instruments had set up an office in

Bangalore in 1984 and petitioned the Indian Government for permission to lease a

64k line to be used for transferring data from India to the United States. The

Indian Government, both at the national and state levels, was worried what would

happen if they provided a 64k line to a foreign company, and it took three years

for them to approve the petition. Connectivity was through a local telephone

exchange in Bangalore that connected to the government-owned long distance

monopoly, BSNL. Service quality remained an issue.

By the early 1990s, both Western and Indian firms were demanding better

connectivity. Understanding the difficulties that business experienced when

interacting with the government bureaucracy, the government established the

Software Technology Parks of India (STPI). This organization was given

permission to provide last-mile connectivity, establish free trade zone status

parks, and generally facilitate the export software business. Bangalore was the

first STPI and has continued to be the most successful. STPI solved the

connectivity problem in Bangalore by installing a satellite dish antenna on its

property (more recently replaced by fiber optic cable). Despite the liberalization of

telecommunications in the late 1990s which led to drastically improved

telecommunications service and lower cost, there remains a role today for STPI

Bangalore that now serves at least 1300 companies.

Bangalore’s rise to prominence was due to a confluence of factors. It was

endowed with an excellent climate, a large pool of universities and governmental

research institutions, and a relatively robust physical infrastructure. In the 1980s,

it attracted US high-technology firms, such as Texas Instruments and Hewlett

Packard, to establish operations there by offering them international

telecommunications bandwidth. When these operations were successful, they had

a demonstration effect that attracted other multinationals. Significant political

support at the state government level ensured that the growth of the IT industry

was facilitated. These factors combined to make Bangalore the leading IT center in

India.

The Indian scene changed in 1978 when IBM decided to withdraw from India, following

the passage of a law imposing joint ownership on all foreign subsidiaries. With IBM’s

withdrawal, the government formed and operated its own software firm, CMC. Though CMC

proved to be only moderately successful,7 it was in software and IT services that India

would become globally competitive. At the time, the Indian firms did little more than

recruiting, while an overseas intermediary secured the contract and the overseas client

decided on the work for the programmers who were sent to the client’s site. The initial focus

of this body shopping was on systems installation and maintenance. Later, the conversion of

clients’ existing applications software into (primarily) IBM-compatible versions began, but

this still operated on the basis of sending Indian workers to the client’s premises. By 1980,

the Indian industry earned $4 million in export revenue, shared between 21 firms, of which

TCS and a sister firm (Tata Infotech) accounted for 63 percent (Heeks 1996).

At the beginning of the 1980s, the Indian software industry was small, but it was earning

much needed foreign exchange. To encourage the growth of the IT industry and recognizing

India’s economic difficulties and foreign exchange shortages, Prime Minister Rajiv Gandhi’s

7 TCS purchased CMC in 2001.

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new government liberalized IT imports in 1984 through the New Computer Policy. Import

duties on hardware were reduced from 135 to 60 percent and on software from 100 to 60

percent. The software business was recognized as an industry, making it eligible for loans

from commercial banks. It was also delicensed, that is, permits were no longer needed to

enter the business. Delicensing was very significant because government licenses were

required in most of the Indian economy. Given that most sectors of the Indian economy

were off limits to new entrants, entrepreneurial energies were drawn toward deregulated

sectors. In addition to creating space for new Indian entrants, wholly-owned foreign firms

producing software for export were once more allowed, though on a licensed basis.

Electronics export processing zones were expanded to include software. TCS located in

the first of these that was opened in Mumbai in 1973. Rentals in the zones were set below

market levels and procedures to establish a business were simplified; power and water were

guaranteed. Most importantly, in 1985, all export revenue from these zones was exempted

from income tax (an exemption that is scheduled to end in 2007). These favorable policies

encouraged additional entrants.

These privileges, particularly the tax exemption, had a significant effect on the structure

of the Indian industry by making the domestic market comparatively less attractive; the

combination of a tax exemption and foreign currency earnings was irresistible. Thus the

Indian software industry was built on satisfying foreign demand for software services, not

products. India was on the verge of bankruptcy during the entire period, and the rapid

growth of the software industry and the fact that it was generating much needed foreign

reserves meant that the government developed a strong interest in encouraging its growth.

An important initiative to encourage growth was the creation in 1990 of the Software

Technology Parks of India system which was authorized to further simplify procedures and

enable exporters to import equipment against their export dollars without licensing or

customs tariffs.

These liberalizations were providentially timed because they coincided with an important

technical change in the software world, namely, the replacement of mainframes by

workstations that generally used the Unix operating system and C programming language

and were commonly linked together in a local area network (Dossani 2006). The adoption of

workstations as a work platform facilitated a gradual shift in the location of work from the

customer’s premises to remote production in India. Further, the adoption of these standards

generated work for Indian firms in converting clients’ installed applications into Unixcompatible

programs. The growth of this activity contributed to an increase in the number

of Indian firms from 35 to 700 by 1990 (Heeks 1996).

Even as the Unix-workstation standard became more prevalent, a number of

multinationals, including Texas Instruments, Hewlett Packard, and Digital Equipment

Corporation, opened wholly-owned subsidiaries in Bangalore to take advantage of low-cost,

high-quality Indian programmers to do various kinds of software-related development work.

As part of the recruitment package, the government agreed to supply them with then scarce

satellite bandwidth. Not much later, a few global banks with long-established Indian

operations, notably Citibank, also began producing custom software in India. By 1990,

Indian custom software developers were responsible for over 80 percent of all software

exports.

Despite obstacles, the Indian software industry grew and accumulated a number of

competencies. In 1991, the Indian government launched another wave of deregulation.

There were 700 firms, including several multinationals, operating in India at the time. Most

of these firms were small by international standards. The two Tata companies, TCS and Tata

Infotech, continued to dominate the industry capturing 48 percent of total revenue. Most

Page 113

firms usually had just one client and so were vulnerable to that client’s fortunes and

disposition. Two-thirds of the typical firm’s exports were to a single US client (Heeks 1996).

By the 1990s, the Indian government had become cognizant of the growing significance of

software exports and the need to encourage this one bright spot in a bleak industrial

climate. It now accepted that the industry required input from abroad. After the earlier

rollback of duties, by 1991 the duties on software had again risen to 110 percent. In 1993,

they were reduced to 85 percent; in 1994, they were further reduced to 20 percent for

applications software and 65 percent for systems software; and, in 1995, to 10 percent for

all software (Heeks 1996). Hardware duties ranged from 40 to 55 percent in 1995, but by

2000 had been lowered to 15 percent for finished goods such as computers, and eliminated

entirely for components.

The global software business was also changing as revenues in custom software overtook

product software. The custom software business was driven by the increasing size of

software programs that firms were using for their internal operations. Growing demand,

coupled with a shortage of US programmers, provided opportunities for the Indian IT

industry to offer its services. The Indian industry focused primarily on assisting in the

writing of the enormous software programs that were used inside large firms to control their

various business functions.

Indian sales efforts were handicapped by government regulations preventing them from

investing foreign exchange abroad. In the early 1990s, legislation was passed that allowed

firms to invest foreign exchange earned from exporting in order to establish offices

overseas. Previously, the Indian firms had only learned about their client’s needs from their

programming staffs on contract overseas, supplemented by occasional senior staff visits to

the United States (and occasionally to other high-wage countries) and client visits to India.

Operating a foreign office strengthened relationships with existing clients and provided

access to mid-sized firms. Some firms established dedicated centers at customers’ sites

(Dossani 2006). At that same time, the Indian government changed its regulations to allow

multinational firms to establish wholly-owned subsidiaries.

The Indian industry continued to evolve and find new software work. One important

opportunity was the Year 2000 (Y2K) problem that became a serious issue in 1998. In itself,

Y2K business was not so attractive as it was mostly unsophisticated work done at the

client’s site, but the Y2K business was important in other ways. It introduced additional

foreign companies to the abilities of Indian firms and programmers, thereby expanding the

Indian firm’s potential customer base and increasing awareness of India as a destination for

software work. Y2K prompted many firms to replace their legacy systems with standardized

software platforms such as Oracle and SAP. This meant that Indians could train on global

standard platforms and receive globally recognized certifications, raising client confidence.

The Current Status of the Software Industry in India

The Indian software and software services industry has experienced remarkable growth

over the last thirty years. The Indian software services industry is based on the use of

global software platforms and thus must purchase software licenses from foreign vendors.

There is little available data on Indian software imports, however. Heeks (1996) cites

Dataquest reports that in 1994-95 these imports were in excess of $96 million, and they

have almost certainly grown many times over as the Indian software industry came to

operate on standard platforms provided by US-based multinationals such as Computer

Associates, Microsoft, and Oracle. To provide some idea of the number of software-capable

people there are in India, according to Oracle (2005), India is the home to more than

220,000 members of its 3-million-strong online developer community, Oracle Technology

Network.

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Though this study concentrates on software offshoring, today not only software but also a

great range of services are being offshored to lower-wage-cost environments (Dossani and

Kenney 2003). Major software firms such as IBM, Microsoft, Oracle, SAP, and Veritas have

relocated work to India. Because of the way the data is reported, it is impossible to separate

the software work from the back office operations. However, as Table 1 indicates, a number

of these firms have large workforces in India. In the case of Oracle and Adobe,

approximately 16 percent of their global employment is now in India, and the number

continues to grow. Other major software firms, all of whose Indian facilities were

established far later than Adobe and Oracle, are also growing rapidly.

One myth about offshore facilities for multinationals is that their employment is limited to

relatively low-skilled programmers. In February 2005, Oracle was advertising for 199

positions in its two facilities in India. Approximately 30 percent of these positions were for

workers with Masters or Ph.D. degrees. Microsoft, newer in India, had a relatively less

highly skilled recruitment profile, but they, too, were recruiting highly credentialed workers

(See Table 2). Hiring such qualified employees, these Indian firms are likely to be capable of

innovation in the future.

Table 3-2: Educational Requirement Posted for Job Openings for Microsoft in India

and China by Highest Degree (Feb. 2005)

MICROSOFT

None Technical Bachelors Masters PhD Total

Beijing 2 0 0 1 0 3

Bangalore 2 0 13 5 0 20

Hyderabad 17 3 57 14 3 94

Source: Martin Kenney’s compilation from various corporate websites (2005)

Like the multinational software firms operating in India, the Indian-owned software

services firms are growing rapidly. They offer their services on outsourced software

projects. As Figure 3 indicates, the major firms are large. Headcount at TCS and at Wipro,

another major Indian firm, have already crossed 40,000 and are continuing to grow at 20-

25 percent per year (CAGR). The stock market believes in these companies and places

much higher values on them than on comparable US firms (Hira and Hira 2005).

Page 115

Figure 3-3: Total Headcount at Major Indian Software Firms by Year

Source: Heng 2005:7, Compiled by Martin Kenney from corporate sources

The prices offered by Indian firms place enormous pressure on management in

developed-nation firms to decrease costs so as to remain competitive. This resolves itself

into a single issue, namely, getting costs per employee down. The way to do this is to move

work to India or some other low-wage country. However, as Table 1 shows, many firms

such as EDS, IBM, SAP, and Cap Gemini have relatively low percentages of their workforce

located in India. From the of competitiveness perspective, this is no longer viable, and their

Indian headcount is expected to increase significantly over the next few years.

There is significant evidence that a movement to higher value-added activities is occurring

in both the Indian firms and the multinationals. In an Internet survey of the Top 86 U.S.

software firms as identified by Software Magazine and conducted in December 2004, 48

firms had R&D facilities in India, while 14 had facilities in China, and only three were

present in Russia (see Figure 4). There is also significant anecdotal evidence that US

software startups are establishing facilities in India to save money and increase their

headcount at low cost. (For further discussion, see Chapter 4.) This may have an indirect

impact on the future growth of US software employment.

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

50000

2001-02 2002-03 2003-04 2004-05

Year

Headcount

Infosys

TCS

Wipro

Satyam

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Figure 3-4: Number of R&D Operations in India, China, and Russia Operated by

Top 86 U.S. Software Firms

0

10

20

30

40

50

60

70

80

90

100

Number

Total

India

China

Russia

Source: Internet searches by Martin Kenney

The Future of the Indian Industry

The Indian software industry is likely to grow in scale, scope, and value-added ability.

There is little reason to believe that offshoring as a process will end in the foreseeable

future, but it could slow down. The enormous investment by leading software multinationals

will expand the number of Indian project managers with global-class managerial skills. This,

plus the relocation of portions of startup firms to India, is likely to result in greater levels of

entrepreneurship and enable firms to sell their skills on the global market at global prices.

As a generalization, it is safe to say that this has not yet occurred, though I-flex, a former

Citibank custom software firm recently purchased by Oracle, is now selling proprietary

packages around the world (I-flex 2005). Other Indian independent firms may soon follow.

The offshoring of IT services and software for export will dominate the near future of the

Indian software industry. There are several possible trajectories. Custom projects could

become more complex and large, leading Indian software professionals to move from

programming into systems integration, systems specification and design. The average size

of projects Indian firms are undertaking has grown from 5 person-years in 1991 to 20 in

2003 (Krishnan 2003). As multinationals deepen their Indian operations, domain skills will

develop in India so that managed services are likely to become more important. This will

match global trends in the outsourcing of applications management and business processes.

Despite the fact that India’s software production for the US market exceeds that of any

other nation, it holds only a small share of the global market for all software value-added

work. The only part of the software value chain in which India has made substantial inroads

is in applications development where it has captured 16.4 percent of the world market. But

applications development is only approximately 5 percent of the entire global software

services market (see Table 3). This implies that there is much room for growth.

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Table 3-3: India’s Share in Various Sectors of the Software Services Industry

(2003)

Global

software

services

spending ($

bn)

Indian

software

services

export

revenues ($

bn)

Indian service

constituents by

percentage (%)

Indian

global

market

share of

services

(%)

Consulting 41.5 0.11 1.9 < 1

Applications

Development

18.4 3.02 54.5 16.4

Managed services 124.9 1.94 35.0 1.6

System Integration:

Hardware/Software

Deployment and

Support

91.7 0.37 6.7 < 1

System Integration:

Applications, tools and

O/S

62.4 0.10 1.8 < 1

IT education and

training

18.5 0 0 0

Total 357.6 5.54 100

Product software 200 1.66 <1

Source: Dossani from Nasscom 2004, p. 36 and 106. Indian figures are for 12 months ending March 2003. Indian

figures do not include product development and design of $ 0.56 bn and embedded software of $1.1 bn.

The Indian software and software services industries are booming. In 2004-2005, the

entire software and services industry grew at 18.5 percent and reached an all-time high of

$16.8 billion of which $4.8 billion was in the domestic market. The export earnings

increased at an annual rate of 30.4 percent from $11.2 billion in 2003-04 to $12.0 billion in

2004-05 (Nasscom 2005). All projections for 2005-06 indicate that it will be yet another

banner year.

A key issue for India is the future of applications development in the value chain.

Applications development may become commoditized just as systems maintenance has,

either due to automation or the development of products that are as good as custom

applications. Applications development has been losing global market share to consulting

and is slipping down the value chain. However, since information is a source of competitive

advantage, it is unlikely that customized application work will disappear altogether. In order

to grow, the Indian industry will have to shift to more complex activities by securing larger

projects, undertaking engineering services, integrating and managing services, or bidding

on projects that include transforming a client’s entire work process.

Increasing the value-added and IP components of Indian software services is difficult. For

example, Cognizant CEO Narayanan argued that India did not yet have the capability to

develop intellectual property, pointing out that R&D’s contribution to overall growth is

minuscule, and multinationals generally use their Indian R&D operations to upgrade existing

products, not develop new ones (Economist 2004). Sarnoff India head, Satyam Cherukuri,

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argues that India has two of the three requirements for innovation, technical skills and

access to capital, but lacks an “indigenous business model” (Economist 2004; D’Costa

2003).

Despite the assertion of many, it is plausible to argue that there is a significant

entrepreneurial movement emerging in India. It could be said that there have been two

clear waves of entrepreneurship already. The first was the establishment of firms such as

Infosys, HCL, and Hexaware who created body-shopping businesses that evolved into the

offshore programming model. Though entrepreneurial in genesis, they were pure labor-cost

arbitrageurs. More recently, that situation may be changing.

The second wave of entrepreneurs consists of a few startups that are producing their own

IP and marketing it globally. One of the most successful is I-Flex which was established by

Indian executives who spun out of Citicorp’s Indian software subsidiary. I-Flex developed a

banking software package that is now being used by more than 50 medium-sized banks

around the world. Today, there are only a few other examples, but given that an increasing

number of Indian managers and researchers are acquiring experience in the Indian R&D

laboratories operated by US firms, there is the potential for more of these startups.

Software offshoring to India is likely to grow not only through the continued growth of

indigenous Indian firms, but also because foreign software firms feel compelled to increase

their employment in India in product development and particularly in software services.

Including not only software and software services but also other services, Accenture hired

1,600 employees in May 2005 in India and has announced that it will be hiring 50,000 more

workers in India, China, and the Philippines in the next three years. IBM, which had 6,070

employees in India in 2002, saw the number rise to 24,150 in 2004. The company has a

target of raising this number to 38,196 in 2005, an addition of 14,000 employees in just

one year. CapGemini India plans to grow to 10,000 employees by 2007. Large

multinationals, such as IBM and CapGemini, are competing with Infosys, Wipro, and TCS for

offshore supremacy. As Indian companies move to global markets in their quest to expand

the offshore model, these large multinationals are moving to low-cost destinations, taking

the big Indian firms head on. The Indian firms are likely to face tough competition in the

near future.

The cost advantage in India may diminish as labor costs increase and the rupee

appreciates against the US dollar. However, interviews conducted by Rafiq Dossani and

Martin Kenney indicated that costs were generally increasing rapidly only for experienced

managers (15 to 20 percent per annum), while wages for beginning college graduates were

increasing more gradually (5 to 10 percent per annum) (Private communication, 2005).

Today, the cost of an Indian college graduate is $6,000-7,000 per year, while a US graduate

is in excess of $40,000 per year. In addition to wage costs increasing among the more

experienced managers, there is a generalized phenomenon of high turnover due to a

supply-constrained labor market. This turnover affects projects and may have a detrimental

effect on capability development both at the individual and corporate level.

There is much discussion of the high quality of the Indian IT labor force, but this may be

deceiving. NASSCOM indicates that only about 27 percent of the employees in the Indian IT

industry have an undergraduate or graduate degree in computer sciences or electrical

engineering. In spite of India having 247 universities and 11,549 colleges in 1997, only 7

percent of the student-age population attends a university (Nasscom 2005). India has 0.3

scientists and technicians per 1000 population, ranking 42 out of 62 countries as ranked by

the World Bank in 1998, below China at 1.3 (ranked 25th) and Ireland at 2.0 (ranked 20th).

This lack of highly educated workers may slow India’s advance into higher value-added

sectors of the software industry.

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Despite much improvement in the value-added per employee, India continues to trail the

United States in this regard. In India, revenue per employee in software services has risen

from $16,000 in 1990 to $33,000 in 2003. However, this is far behind the US average of

$142,000. This differential suggests that US workers are still more productive than those in

India, probably because a significant portion of the US revenue is in software products

where revenue per employee is much higher than in software services.

Improvement of the value-added per employee will require a continued upgrading of the

Indian workforce. The leading Indian software firms are investing in their workforces, but

there is only so much training an individual firm can undertake particularly in the high

turnover environment that characterizes the Indian labor market. Thus much of the

responsibility falls on the central government which is the main financier of tertiary

education. While India has greatly expanded the university system, problems with quality

appear to have deterred enrollment.

The interaction between university and industry is minimal. There are few academicindustrial

research partnerships as well as few consultancy assignments for faculty in

industry. On campus, little independent research is undertaken. Until recently, faculty (even

at the Indian Institutes of Technology (IITs)) have not been expected or funded to do

research. Only in 2005 did the Indian government appropriate $250 million to establish a

National Science Foundation. For example, at IIT Delhi, the value of sponsored research and

consultancy assignments in 1998 was only $4.5 million (Parthasarathi and Joseph 2002).

Faculty salaries are low, and NASSCOM concluded, “Over the years, there has been a

general decline in the quality of faculty in Indian universities” (Nasscom 2002). The average

number of citations over a five-year period for a faculty member at the Indian Institutes of

Technology is less than three. This compares with 45 per faculty member at MIT and 52 per

faculty member at Stanford University (Nasscom 2002). The country produces only 300

master’s degree graduates and 25 Ph.D.s in computer sciences each year, compared with

US numbers of 10,000 and 800, respectively. (For more information on the Indian

educational system, see Chapter 7.)

The Indian subsidiaries of multinationals are perhaps even more important than the

independent Indian firms. The reason is that the multinationals are more willing to

undertake high value-added activities such as software product development within their

own captive firm in India than they are to send the work to an Indian independent firm. It

is within these subsidiaries where the highest value-added activities, such as globally

directed research and development, take place. For at least the medium term, India should

be able to retain its position of primacy for software offshoring from the English-language

world. In the longer term, unless India makes an even greater effort to upgrade its

universities and the technical capabilities of their graduates, China may become an

important alternative destination.

3.5 China

China is one of the fastest growing economies in the world and is now the seventh largest

economy in the world in terms of gross domestic product and the second largest economy in

the world when the GDP is corrected by purchasing power parity. During the last two

decades, it has become a manufacturing powerhouse. In 2004, the United States had a

$162 billion trade deficit with China, the largest trade deficit with any single nation in US

history.8

8 These statistics can be found at

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China manufactures a broad range of goods, including IT products such as personal

computers, routers, monitors, cell phones, and handheld devices. The manufacturing of IT

products in China is growing more rapidly than China's overall industry. From 1990 to 1999,

the Chinese IT industry grew at a rate of 32 percent per annum (Dong 2004). From 2002 to

2003, sales increased at approximately 34 percent to reach $235 billion, and China became

the third largest IT equipment producer in the world (STAT-USA 2004). IT exports continue

to grow rapidly. For example, in the first seven months of 2003, China exported $80.6

billion, representing approximately 50 percent of its total production (China Venture Capital

Research Institute 2004). The strength of the Chinese IT hardware industry is shown by the

purchase in 2005 of IBM’s PC division by Lenovo. There is ample reason to believe that

China may soon become the largest IT product exporter in the world.

China and IT Software and Services

Much less is known about the Chinese software industry than is known about the Indian

software industry. The Chinese IT and software and service industries (ITSS) do not appear

to be having an important impact on the global economy, though as we shall discuss later in

the section on Japan, there are Chinese ITSS exports, and they are expanding rapidly but

from a far smaller base than in the case of India. According to the Chinese Software

Industry Association, there are 300,000 workers employed in over 6,000 firms, of which

approximately 160,000 are software professionals, approximately 25 per firm (Tschang and

Xue 2005, 133). According to the Ministry of Commerce, the revenues of the Chinese ITSS

industry increased from $7.17 billion in 2000 to $19.35 billion in 2003. During the same

period, software exports increased from $250 million to $2 billion in 2003 (China Software

Industry Association 2005). A recent report (Krishnadas 2005), notes that China's IT

services revenues are rising but are barely half of India's $12.7 billion. Growth is driven by

internal demand, and exports make up only 10 percent of total annual software service

revenues. The Chinese Software Industry Association indicates that 60 percent of Chinese

software exports in 2003 went to Japan and another 21 percent went to Southeast Asia to

nations using Chinese characters (Liu 2004).

Despite the impressive growth, the Chinese software export industry faces many

obstacles. It is extremely fragmented, and few firms are capable of undertaking large

projects (Krishnadas 2005). As of 2003, only six Chinese firms had received certification

through the Carnegie Mellon Software Engineering Institute's Capability Maturity Model

Integration, and most of these had not achieved CMMI Maturity Level 3 (China Venture

Capital Research Institute 2004). In contrast, all top 30 Indian software outsourcing firms

had already received CMMI Maturity Level 5 (Krishnadas 2005).

Given China's role as a manufacturing center for the global economy, many manufactured

products it exports contain embedded software. Programmers preparing embedded software

often need to work closely with designers and manufacturers, and there is some evidence

that a portion of this work may be relocated to China (Linden and Brown 2005).9 At the

moment, there are no estimates of the size of this market, but it could be significant.

The Chinese firms providing IT services to Western nations vary by size, but most are

relatively small. There are Chinese firms offering offshore software services for the US

market. At this point, the Indian firms dwarf them but, over the longer term, Chinese firms

http://en.wikipedia.org/wiki/List_of_countries_by_GDP_%28nominal%29;

http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP);

http://www.economywatch.com/world_economy/china/;

http://www.census.gov/foreign-trade/statistics/highlights/top/top0412.html#total.

9 India also is developing a strong embedded software design capability, both at the multinational and

Indian firms.

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may provide competition to India in providing service to US businesses. A number of the

large Indian software offshoring firms have established subsidiaries in China for the purpose

of capturing business in China and servicing the Asia-Pacific market. Meanwhile, the

Chinese networking equipment firm, Huawei, employs nearly 800 engineers in India and has

announced plans to increase the number of engineers to 2,000 by 2006 (Press Trust of

India 2005). Although the outsourcing relationship between China and India remains tiny,

given the growth both nations are experiencing, it is possible that they could eventually

become significant.

In contrast to India where exporting is the goal of both the India independents and the

multinationals, much of the IT and software services growth in China is in the domestic

market. Multinationals have developed large operations bent on localizing their products and

software for the Chinese market. China is the largest developing country market in the

world, and, for certain products, it is rapidly becoming one of the overall largest markets in

the world. Many foreign goods must be localized to meet the special requirements of the

Chinese market. For this reason, China is becoming an increasingly important location for

R&D facilities in a wide variety of industries, including software and electronics (Zedtwitz

2004). In an effort to tap the Chinese market and utilize Chinese production prowess, a

number of US software firms as well as US, European, and particularly Taiwanese

electronics firms have established R&D facilities in China. The Shanghai area is an important

stronghold not only for computer machinery assembly, but also for semiconductor

manufacturing and, on a slower track, semiconductor design (Reuters 2005). Most of these

operations are geared to adapting products for the local market or doing production

engineering; however, some are developing global product mandates or are doing research

for the firm's global operations. One of the most celebrated of these is the Microsoft

research laboratory in Beijing which as of November 2004 employed approximately 170

scientists and planned to add 80 more (Heim 2003). According to Huang (2004), "more

than 70 technologies developed [there] are already used in Microsoft products, including

software for Windows operating systems and graphics packages for X-box video games.

More of the lab's latest software is slated for the next version of Windows due out in 2006."

Global software leaders such as SAP, Oracle, and Adobe are also establishing or expanding

their Chinese operations.

Given the general economic growth in China, the Chinese market for software is

expanding rapidly. Today, US packaged software firms are having some difficulty in the

Chinese market due to uncompensated software copying. Though China has joined the

World Trade Organization, it seems likely that these difficulties will continue. One possible

answer to the uncompensated copying is the current Chinese effort to move to open source

software (Marson 2005). Were this to come to fruition, it would dramatically decrease the

problem of uncompensated copying, but it would also have a significant impact on the

future prospects for growth of the US packaged software industry.

Conclusion on China

Given the past growth record, the apparent opportunities, and the importance given to

the software industry by the Chinese government, the Chinese software industry is likely to

continue growing more rapidly than the rest of the Chinese economy, and probably faster

than the software industry in the rest of the world. In the short term, the Chinese software

and software services exports are focused on Japan (see Section 3.6). In the long-term,

China could possibly emerge as a competitor to India in the general software export market.

More easily predicted is that China will become an enormous market. Given the relative

paucity of data, it is difficult to predict when China will become one of the largest software

markets in the world, but given the number of Internet and cell phone users, the rapid roll

out of broadband networks, and the gadget orientation of Chinese consumers, it might

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happen quickly. However, it seems unlikely that Chinese firms will be able to compete with

the major Indian IT and software services firms in the near-term.

3.6 Japan

The Japanese software and software services industry had sales of about $140 billion in

2004 and is the second largest single-country market in the world, accounting for 10.8

percent of the world’s IT industry. Further, IT and software services is the fastest growing

industry in Japan. In 2003, there were 5,482 information service companies employing

567,060 workers in Japan. Of these, technical positions included 240,096 system engineers,

114,479 programmers, and 7,398 researchers. The number of software engineers in all

industries is about 800,000. Thus, more than 40 percent of software engineers are working

in the information/service industry (JISA 2004a).

As Table 4 indicates, Japanese software imports were $2.9 billion in 2003.10 The type of

software imported is specific to the nation from which it was imported. The United States is

the largest source of software imports, and it overwhelmingly provides system and

applications software. In contrast, the imports to Japan from China and India are mainly

custom software. Japan imported $102 million worth of custom software from China and

$38 million from India. Japan also received $262 million in software services from China and

another $63 million from India (Umezawa 2005a).

Table 3-4: Japanese Software Imports in 2003 (US$ millions)

Basic

Applications Applications Custom

PC

Games

IT

Outsourcing Total

U.S.A. 686 1,874 47 6 49 2,606

China 1 1 102 0 262 104

Ireland 0 45 0 0 0 45

India 2 0 38 0 63 40

Australia 0 0 26 0 26 26

Others 6 27 43 0 91 76

Total 695 1,947 6 2,901

The Japanese software industry differs significantly from that of the United States.

Outside of a few fields such as game software, Japanese software firms develop custom

software for the Japanese market. Few Japanese companies produce packaged software

products. For those firms that do prepare packages, their market is almost exclusively

domestic, and the entire industry, not counting game software, exports only $93 million.11

10 The true value of the imports is much larger because all major foreign software package firms have

subsidiaries in Japan. For example, Microsoft’s Asia-Pacific earnings in 2003 were $3.437 billion

(Microsoft 2004), and Japan is as large as the other markets combined so Microsoft alone probably

earned more than $1.5 billion in Japan.

11 For further information on Japan and offshoring, see Umezawa (2002; 2005a; 2005b).

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There is no authoritative data on offshore software development for the Japanese market.

The most reliable data comes from surveys conducted by the Japan Information Service

Association (JISA). According to Tsukazaki (2002), 19,000 foreign engineers were working

in Japan in 2001, and, during that year, 3,943 foreigners acquired the status of engineer. Of

these, 61.8 percent were estimated to be software engineers. In the JISA sample, Chinese

professionals were by far the largest group represented, followed by Koreans, and a

relatively small number of Indians.

The typical pattern in the past has been for Japanese firms to import Chinese or Indian

software engineers to work on projects in Japan. This has changed because the cost of

dispatching Chinese software engineers to Japan has increased to the point where it is no

longer attractive (Umezawa 2002). The more typical pattern in 2005 is that a Japanese

customer identifies a need for custom software and engages a Japanese software firm. The

Japanese software firm then contracts with a Japanese subsidiary of a Chinese firm to have

the work done either by Chinese programmers in Japan or, increasingly, by programmers

located in China.

Another mode of offshoring has emerged in which Japanese firms invest in China to form

a wholly-owned subsidiary or a joint venture with a Chinese firm. The most popular

locations for Japanese firms to operate subsidiaries in China are Dalian and Beijing. The

other mode of offshoring from Japan is for Western multinationals to move their

programming and back office functions from Japan to a lower-cost environment in China.

Dalian's software industry has grown (from a small base) at over 50 percent annually in

sales volume and reached $544 million in revenues in 2003 (Xiong 2004).

Japanese firms, such as Fujitsu, NEC, Sharp, and Sanyo have subsidiaries to produce

software in India. For example, through a publicly listed affiliate, Fujitsu (in 2005) employs

more than 2,000 workers in its four facilities in Pune. It is difficult to establish whether

these operations support the Japanese market or the English-language operations of

Japanese firms. Despite great effort on the part of Indian vendors, with only a few

exceptions, their sales in Japan have been small.

Impact on Japan of Offshoring

The impact on Japan of IT and software services offshoring is uncertain for two reasons.

First, the software services offshoring phenomenon is recent so that patterns are not yet

well established and data is scant. Second, Chinese vendors generally do not conduct

business directly with their Japanese customers so the role of the Chinese company is

somewhat obscured. There is typically an intermediary such as a Japanese software firm or

a US or European-based multinational, that holds the contract with the Japanese client; the

Chinese company is a subcontractor. The Japanese software firms have typically retained

the higher value-added activities in Japan.

Actual sales are relatively small. While sales of the Japanese information services industry

are $141.7 billion, the share offshored is $480 million or only 0.3 percent of the total sales

(Umezawa 2005a). This may underestimate the total amount of offshoring because many

multinationals operating in Japan have begun servicing the Japanese market from China or

India. For example, in 2004 the US consultant firm, BearingPoint, established a

development facility in Dalian with 60 employees, and it planned to increase employment to

1,000 “as soon as possible” (Thibideau 2004). Although Dalian has just begun to grow as a

software offshoring center, Western multinationals there already include IBM, General

Electric, Accenture, Dell, and SAP. Among the Japanese firms in Dalian are Sony,

Matsushita Telecom, Mitsubishi, Toshiba, Nokia, Omron, CSK, Alpine, Furuno Softech, FTS,

and Sino-Japan Engineering (Xinhua News Agency 2003). Despite this rapid growth, these

operations are still not significant enough to have much impact on the Japanese economy.

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The movement of Japanese software production to China is likely to continue. However,

there seems to be a division of labor emerging with Japan undertaking the higher-end

software development, while the Chinese subsidiaries and subcontractors undertake the

more mundane coding functions. This is borne out in the China Venture Capital Research

Institute (2004) assessment of the situation, “the export to Japan was mostly done in the

form of outsourcing, just like traditional manufacturing, what was subcontracted to our

country was only the development of lower-layer modules.”

Conclusion on Japan

The amount of work offshored to China is likely to increase due to the increasing pressure

to lower prices. Users are beginning to require that their Japanese vendors offer software

development prices that assume offshore development in China. Given the strong linkages

Japanese firms have with their customers, it is unlikely that Chinese firms will be able to

establish direct relationships with Japanese customers. However, Japanese firms will be

under pressure to reduce costs and thus will almost surely have to increase the scale of

their Chinese operations or form alliances with Chinese firms. This suggests that Japan will

not be immune to the pressure to offshore.

3.7 The European Union – Western and Eastern Europe

After the United States, the European Union as a whole is the second largest software

market in the world. In 2004, Germany accounted for 8.1 percent (15.4 billion Euros), and

the United Kingdom accounted for 7.1 percent (13.5 billion Euros) of the world software

market (Heng 2005). This is much smaller than the US share of 44.5 percent (96.6 billion

Euros). However, this statistic is somewhat misleading in that the Europe Union is not yet a

single market but is rather a loose confederation of markets with different customs and

languages. Europe has only one major software products firm (SAP). With the exception of

SAP, US firms are dominant in Europe’s packaged software market. Europe has no major

software service firms. The European market for IT services is divided by national language

differences. For example, Siemens Business Services is a leader in Germany, while Cap

Gemini is a leader in France. The giant US software service providers, such as IBM, Hewlett

Packard, and Accenture, play an important role in European markets where they usually

face firms that are only significant in their home nation (see Table 3-1). The greatest

European strengths are in software embedded in other products. Unfortunately, there are

few statistics publicly available to gauge the size of the embedded software market.

The European Union has been slower to embrace offshoring than the United States. The

United Kingdom was the first European country to do a sizable amount of offshoring, and it

is responsible for almost two-thirds of the IT and service jobs offshored from the European

Union (see Figure 3-5). Thirty percent of the jobs offshored come from Germany and

Benelux, and there is a noticeable increase in interest in offshoring in the German-speaking

nations recently. French, Italian, and Spanish firms have been more reluctant to send work

offshore.

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Figure 3-5: European Offshore Services Spending by Region

Source: Parker 2004

Cost pressures are driving Continental European software and software services firms to

consider offshoring. According to a study by the consulting firm Roland Berger Strategy

Consultants (2004) in which executives at 93 major European firms were interviewed,

almost 40 percent of the firms have already relocated some services offshore, and 50

percent of all of the firms intended to offshore more activities. The firms already offshoring

gave the strongest indication of willingness to offshore new functions in the future. There is

anecdotal evidence that offshoring is increasing across Continental Europe. For example, in

2005, the Renault-Nissan alliance awarded IT services outsourcing contracts worth

approximately $600 million to two US firms, Hewlett Packard and Computer Sciences

Corporation, and the French firm Atos (Ovum 2005). With this outsourcing contract, much

of the work will be transferred to lower-cost environments since all three of these firms

have global operations.

Where the work is sent divides primarily along language lines. The United Kingdom sends

most of its work to India, while the Western European nations speaking languages other

than English are more likely to look to Eastern Europe. Due to the European Union’s

expansion into Eastern Europe, this is a natural near-shore location for the movement of

services. A significant percentage of Eastern Europeans speak a Western European language

such as German and, in the case of Estonia, Finnish. Hungary, Poland, and Romania are

seen as prime sites for this nearshoring work.

Although many studies predict that Eastern Europe and Russia will receive much of the

future offshoring work from Continental Europe, Figure 6 shows that, for Europe overall, the

most attractive location by a considerable margin will continue to be India. India wins on

price. For example, even though Romania is one of the lower-wage Eastern Europe

destinations, it still has wages that are higher than those in India. India also wins on

language and culture factors for the United Kingdom.

0

500

1000

1500

2000

2500

3000

2004 2005 2006 2007 2008 2009

Year

Million Euros

UK/Ireland

Ger/Switz/Aus.

France