GIANT STEPS IN ASIA

A FEW YEARS AGO, CHINA STARTED TO become the dominant world supplier of goods such as microwave ovens, photocopiers and artificial Christmas trees. Now it is producing significant quantities of fairly sophisticated items like memory chips, computers and mobile handsets, and moving into new territory such as telecommunication switching systems. The software for these products might also easily be developed in India where all sorts of services are being provided. Can these giant economies maintain their advantage?

The growing competitiveness of Chinese manufacturing means that companies are increasingly relying on China as a source of products and components. Sometimes this is achieved through subsidiaries and in other cases by sub-contracting to Chinese companies.

A new type of firm - the contract manufacturer - is also emerging to produce a wide range of goods for global clients. The largest of these is Flextronics, a Singaporean company which originated in the United States and runs manufacturing complexes in China and elsewhere in Asia. It makes products for global companies, such as printers for Hewlett Packard and X-Box games consoles for Microsoft.

The long-standing assumptions that western companies would only outsource manufacturing processes, and that China would be the major beneficiary, are being challenged by the emergence of India as an increasingly important location for the transfer of services sector jobs from the west.

India's success is focused on Bangalore, Asia's fastest growing city, where seventy five thousand software professionals work in almost a thousand units. Bangalore's electronic revolution began in 1984 when Texas Instruments started offshore development. What had been known as India's garden city rapidly transformed itself into the country's Silicon Valley, home to almost half the world's highest rated software companies.

Although the infrastructure is under increasing strain, its advantages should ensure continued success. It is hoped that the second generation of centres, such as Hyderabad, Pune, Chennai and Gurgaon outside Delhi - will replicate Bangalore's success.

Another pioneer in Bangalore was the American based General Electric, which established the $80million John F Welch Technology Centre, its first and largest research and development centre outside the US. By October 2003, it had filed for 95 patents.

General Electric now has a 70:70:70 rule of thumb, whereby seventy percent of its processes should be outsourced; seventy percent of outsourced processes should be sent offshore and seventy percent of the offshore outsourced processes should be done in India.

These corporate pioneers were taking advantage of India's pool of highly qualified mathematicians and computer software specialists developed by the country's elite educational establishments, such as the six Institutes of Technology. They accept less than two percent of the one hundred and seventy thousand applicants annually. English-speaking, with unexciting job prospects in Indian industry, this reservoir of talent was a world-class resource, waiting to be discovered by the international software industry.

Across time zones

The real integration of the Indian software sector and the global economy came in the late 1990s, as Indian companies tackled potential problems at the millennium. Once these links were made, they continued - enhanced by the important role of Indian software specialists who had cut their teeth in Silicon Valley. After that, cost advantages from relatively low salaries gave Indian companies an advantage in bidding to set up systems in logistics or accounts, for instance.

Underpinning these trends has been the revolution in world communications that, at a trivial level, allows western customers to have queries answered by an Indian call centre. In more sophisticated terms, this revolution integrates Indian research laboratories with those in Europe, the US or Japan to allow 24-hour working, with projects passed between time-zones as the day progresses.

Building on their strengths, Indian companies also moved into IT-enabled services. While call centres get most publicity, a wide-range of back office work now takes place in India. This type of task is also changing. Until recently, the financial services sector provided the majority of outsourced work. Slowly, but apparently surely, Indian companies are attracting the back office functions of law firms and medical services, undertaking tasks like transcription.

Although the transfer of such services has already done wonders for India's gross domestic product, its employment reach is still relatively small. IT and back office work is forecast to involve four million people by 2008. The country's entire private sector has just eight million workers - in contrast with the twenty million people employed by foreign companies in China.

The potential, though, is great. Gartner forecasts that the global market for outsourcing will rise to $253 billion by 2008, from $181 billion in 2003. India should be able to attract a sizeable fraction of this, and, given that its gross domestic product is just $570 billion, continued growth could well transform the economic structure.

But how desirable and sustainable is this Indian shift to services compared with China's emphasis on manufacturing?

Skills to sell

On the one hand, the software sector pays well by Indian standards and since wages make up a relatively high proportion of service cost - perhaps as much as forty percent - its benefits to the local economy should be relatively high. Labour is a much less significant cost in low-skilled Chinese manufacturing plants, and a relatively high proportion of the fixed investments like machine tools come from overseas. So, India's software industry may well have a greater proportion of local content than many of China's export manufacturing plants.

On the other hand, India's economic dependence on relatively skilled software specialists makes this sector vulnerable to wage inflation. Last year this was almost fifteen percent, warning information technology may be more vulnerable to new sources of cheaper-labour competition than China's manufacturing operations.

In the case of China, wages are a much lower proportion of unit costs. For the forseeable future, wage inflation should be manageable despite short-term bottlenecks as hundreds of millions of people are yet to move out of agriculture. China's one child policy may affect industries that have traditionally employed women. Although there are some signs of overheating in the relatively developed coastal provinces, the more labour-intensive operations are already shifting inland towards the next generation of first-time industrial workers.

One key problem in India is its education system, notably the issue of illiteracy. Over one fifth of males between 15 and 24, and over one third of the equivalent females are illiterate according to 1999 figures. This compares with Chinese totals of one percent and four percent respectively.

True, India turns out around two million graduates each year, but many of these lack the skills required for offshore services operations. The elite Indian Institutes of Technology, so central to the outsourcing sector, only handle three thousand students a year.

Those with the skills have found themselves in great demand in new businesses, leading to rapid wage inflation. A recent no-poaching agreement between leading Indian companies is unlikely to restrain this.

All the indications are that the Indian drive into the world's services market can be sustained. General Electric's research laboratories in Bangalore, have been joined by similar investments in India by Microsoft, Intel and Cisco. Companies such as these are unlikely to walk away, even if there is some overheating in the market for software programmers. As global communications infrastructure continues to improve, what these giants are doing in India will become commonplace for smaller competitors.

Continued communications improvement will also mean that call centres and a general shift of labour-intensive business processes will continue in parallel with software developments. Effectively, whenever work can be carried out on a computer network, India can potentially compete.

Poor infrastructure

But these sectors will face problems. In the short-run, wage inflation means that some Indian outsourcing companies are turning to China for lower-cost labour. And of course information technology enabled service can be moved between continents with far more ease than a manufacturing plant.

More worryingly the sector has relatively few friends in the Indian political system. The general election last May produced a resounding defeat for the campaign by the BJP government which had highlighted the country's emergence on the high technology scene. The rural poor could not see the benefits for them.

This means that national and state governments are unlikely to give urgent support to infrastructure projects to ease the development of these booming sectors. Executives of all nationalities are exasperated with the way rapid expansion in Bangalore is held back by congested roads, an inadequate airport, power cuts and erratic water supply.

China also has such problems, but its political leaders do not have to worry about electoral defeat. They can focus much more than their Indian counterparts on supporting the high technology parts of the economy.

India's push into the world's service sector is just as firmly based as China's move into manufacturing, though the Indian development is more narrowly based, resting very heavily on educational skills.

This is not to dismiss the contribution of rising Chinese educational standards to the explosion of manufacturing, but people moving from the agricultural sector will find it easier to take the low-skilled factory jobs being created in China than the fringe jobs in the Indian service sector. In the latter case, new recruits need more than manual dexterity; they will probably have to know some English and be able to work in a computer-driven environment.

In both countries, though, major pools of dedicated, low-paid workers are being linked to the global economy. These giant economies are moving into the kind of manufacturing-based catch-up process that Japan went through from the 1950s, and the Four Dragons - South Korea, Taiwan, Hong Kong and Singapore started in the 1970s. India's success with the service sector is a genuinely new phenomenon, which raises questions about the west's ability to adjust to the breadth of the new competition.

The conventional economic wisdom was that the west could lose manufacturing jobs, because it would move into more productive, high-grade service work. The emergence of India as a potent challenger in the services sector makes this kind of transition look more problematic.