Indian IT: Privileged, Protected and Pampered

India’s IT industry does protest too much.  Its latest peeve is that the US has decided to steeply hike, from $2300 to about $4300, the cost of a H-1B visa required for entry into the US of temporary skilled workers from abroad.  The new Border Security Bill passed by the US Senate and signed into law by the President, which incorporates the relevant provisions, is in its view protectionist and discriminatory.  It is seen as reflecting the political misuse of security concerns to appease local workers in the run-up to the Congressional elections in November by penalising foreign companies using legitimate means to deliver IT or IT-enabled services.

The industry is also peeved because Charles Schumer, one of the Senators who piloted the bill through Congress, referred to Indian IT outsourcing companies as “chop shops” — derogatory slang for sheds in which stolen cars are stripped of their parts for subsequent sale.  The Senator has subsequently clarified that what he meant was that they were “body shops” and has apologised for his error.  But, with the debate referring to the fact that the largest users of H-1B visa are IT “giants” such as Infosys, Tata Consultancy Services, Wipro and Mahindra Satyam, the “body shop” label is also an indictment of an industry that sees itself as a technology leader and a symbol of India’s post-reform success.  It suggests that the Senator has not retracted his view that foreign, especially Indian, IT companies “outsource good, high-paying American technology jobs to lower wage, temporary immigrant workers from other countries.”

But the Indian government too has come out in defence of its post-reform poster-child.  India’s Commerce Minister, Anand Sharma, has reportedly written to the US trade representative, Ron Kirk, protesting the new legislation, describing it as “inexplicable” and stating that it would have “an adverse impact on the competitiveness and commercial interests of Indian companies sending professionals to undertake projects locally for American customers in the US.”  An estimate, of uncertain reliability, doing the rounds is that the US move would increase visa costs for Indian companies by as much as $200 million.

To clarify, the bill while having an impact on the Indian IT industry is not directed solely at it.  Its stated concern is to strengthen security along Mexico’s border with the United States by hiring another 1000 border patrol agents and 500 immigration and customs officials, besides deploying additional drones to monitor the border.  With this drive against illegal Mexican immigrants at the border estimated to cost around $600 million, the bill seeks to finance the cost of strengthening border security by hiking visa fees paid by companies employing more than 50 people in which more than half the work force consists of temporary migrants holding H-1B or L-1 visas.

It is obvious that the Bill is political in nature in that it seeks to appease two constituencies in the run-up to elections in November.  One is a section of the local population in states like Arizona who feels that illegal immigration across the Southwest border has gone out of control.  The other is American workers who having just come out of a recession are faced with inadequate employment recovery and see foreign workers as outcompeting them by underselling themselves.  The Bill is also protectionist in intent, since foreign companies would be employing a high share of temporary skilled workers brought from abroad and therefore would be more affected by this particular levy.  Interestingly, the bill was passed by unanimous consent and signed into law very quickly, pointing to the political consensus around the issue.  What is surprising is that the Indian industry expected the US government, Democrat or Republican, to act differently.  In fact President Obama is possibly more intent than many Republicans on bringing jobs he sees as diverted abroad or to foreigners back to Americans.

Part of the reason the industry refuses to recognise that it is prone to actions of this kind is possibly the fact that it has been pampered too much at home.  More than 10 years after it was first granted special tax benefits, the industry, which sees itself as being in the forefront of an emerging knowledge economy, as having pioneered a global delivery model, and could perhaps boast that it has delivered the largest number of first-generation millionaires in the country, fights hard to keep those concessions.  In doing so, it is not above board.  It constantly demands that the government “keep off”, arguing that its rise has been driven purely by private initiative, when actually implicit subsidies (tax concessions), liberal trading rules and infrastructural support from government agencies have been crucial in delivering large profits and driving market valuations.  Nothing is more revealing than the fact that an Annexe on revenues foregone in the papers relating to Budget 2010-11 estimates that in 2008-09 the “effective tax rate” on 8166 firms identified as “Software Development Agencies” was 11.8 per cent and that on 6493 firms identified as “IT Enabled Services, BPO Service Providers” was 13.1 per cent.  The effective tax rate is the ratio of total taxes paid [including surcharge and education cess but excluding Dividend Distribution Tax and Fringe Benefit Tax] to the total profits before taxes [PBT].  This compares with statutory tax rate of 33.99 per cent which should have applied if no concessions were being provided.  Since input and capital costs are low in this service industry, and cheap skilled labour is its strength, profits do constitute a high share of per worker incomes.  This concession is therefore a bonanza, which even today the industry zealously lobbies for.

The industry is also privileged relative to the IT hardware sector.  While the early thrust of information technology policy in the country was to build a strong hardware industry, at least in the area of small computers where the domestic market was bound to be large in course of time, since the 1990s regulations on access to imports of hardware have been completely liberalised and duties have been slashed to extremely low levels to support software and services export units.  In the event, the domestic hardware market has been swamped by foreign players importing complete knocked-down machines.  Domestic demand is largely serviced by foreign brands, with a few stray domestic players accounting for a declining market share, while the domestic “industry”, including players who started in hardware such as Wipro, are focused on the services export market.

Given these special privileges granted over a prolonged period, one question that has constantly been posed is whether there are adequate reasons to justify their provision.  One ground on which it can be justified is, of course, the fact that the industry is an important foreign exchange earner.  With manufacturing having failed to live up to the government’s claims on what liberalisation would do to India’s industrial competitiveness and export success, this is indeed a contribution that cannot be belittled.  But that definitely does not warrant a set of tax concessions that make the effective tax rate less than half of the statutory rate and remain in place for as long as they have.  Further, if a visa fee hike can be labelled a protectionist measure that violates trade rules, a tax concession of this kind can be attacked for amounting to an export subsidy that does the same.

The other ground on which prolonged and generous government support can be justified is that the industry is a technology leader and furthers India’s push into high technology exports.  This is an area where both evidence is thin and unanimity lacking.  The industry argues that even though it is a services exporter, it has over the years moved up the value chain and into higher-margin, high-technology areas, rather than surviving on the legacy of cheap skilled labour that the Nehruvian import-substituting strategy has left behind.  However, while all of the industry cannot be dismissed as a high-tech sweat-shop exporting cheap skills through actual (H-1B visa-based) or digital migration, there are a number of features of the industry that are disconcerting given its lifespan and the support it has garnered from government.

To start with, while the technology issue remains unresolved and the claims of high- or low-technology dominance unproven, it is true that there are very few software product markets where the Indian industry has found a foothold and even fewer proprietary products in which it commands significant market share.  India is a service provider and matters in products only as a supplier of hired engineering support.  Secondly, the industry has in recent times been characterised by a much faster growth of the BPO segment, which on no account can be considered a high technology area.  Third, the US still accounts for around 60 per cent of the industry’s exports and the UK for around 18 per cent, making the industry extremely vulnerable to developments in specific markets.  And finally, as is evident from the current controversy over the visa fee hike, the industry is still significantly dependent on onsite delivery of services using cheap Indian staff rather than more expensive local workers, making it susceptible to changes of the recent kind in rules governing the movement of temporary workers.

Put these together and the weaknesses of an industry that has received privileged treatment for more than a decade seem to be one too many.  Rather than using its lobbying strength to conceal these weaknesses so as to continue to be favoured, the industry could look inwards and address some of these problems.  It obviously has the clout to still influence domestic government policy.  But to believe it can pressurise the government of a foreign country which is its main market to ignore its own domestic compulsions is to be overcome by hubris.  Maybe the problem is too much protection and pampering at home.  Depending less on government support at home could possibly encourage the industry to adopt strategies to meet the rising competitive challenge abroad without having to pay workers less than the going wage.

C.P. Chandrasekhar is Professor at the Centre for Economic Studies and Planning at Jawaharlal Nehru University.  This article was first published by MacroScan on 31 August 2010; it is reproduced here for non-profit educational purposes.

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