The myth of India's outsourcing boom
Vijay Joshi, fellow of Merton College, Oxford
November 16, 2004

India's steady rise in national income - by nearly 6 per cent per year for two decades - has made the country one of the world's top growth performers. But this growth has also been highly peculiar. It has been "jobless"; and it has been driven more by services than by industry. 

In other relevant high-growth economies such as China, Indonesia, Malaysia, South Korea and Thailand, the share of industry doubled between 1960 and 2002 to reach 40 per cent or more of gross domestic product. 

Industrial expansion, in turn, was powered for a decade or two by exports of labour-intensive manufactured goods. In contrast, India has not had a broad-based industrial revolution: industry's share of GDP rose from 20 per cent in 1960 to only 27 per cent in 2002. Moreover, industrial development was capital-intensive and inward looking and India did not have an east Asia-style export boom. The consequences for employment have been dire. In the past 10 years, employment in the organised manufacturing sector has fallen; in services, it has barely changed. Total employment, which includes informal, unorganised jobs, has done somewhat better and has risen by about 1 per cent per year in the last decade. But this must be put into perspective by noting that first, there remains a large amount of unemployment and low-productivity employment, and second, that the labour force is projected to grow by 2 per cent (8m people) per year for the next 25 years while the composition of the population shifts towards adults of working age. This "demographic bonus" could boost growth but only if the rapidly growing labour force is productively employed. 

Could India achieve its objective of faster growth of employment and output and quicker reduction of poverty by continuing along its present path? I doubt it. Faster growth in agriculture is necessary - indeed essential - but not sufficient. Agriculture contributes 22 per cent of GDP and employs 60 per cent of the labour force. The annual growth rate of India's agricultural output has been about 2 per cent in recent years. It would be unrealistic to expect it to rise much above a trend rate of 3 per cent; and historical experience in other countries shows that even high-productivity agriculture cannot absorb more than a small part of the working population. Services constitute 51 per cent of GDP. In the past decade, services have been growing at 8 per cent per year, industry at 6 per cent. Again, history and international experience indicate that this disparity cannot continue at India's stage of development. Moreover, growth in services has been as "jobless" as industrial growth, which suggests that it has been skilled-labour intensive. 

Some people think that the information technology sector could be India's saviour. But its quantitative significance in the near term is extremely limited. IT-related output is currently less than 1 per cent of GDP. More significantly the sector employs less than 1m people. This could increase by another million by 2010. While undoubtedly helpful, it pales into insignificance when one considers that India's labour force will rise by 40m by 2010 to an estimated 450m people (and much of the rise will occur in backward states). We must remember also that growth of the IT sector will be constrained by the rate at which the supply of educated labour can be increased. Note that only 5 per cent of India's relevant age-group receives college education. 

The IT sector does not answer the employment needs of millions of uneducated people. They require industrial blue-collar work with most training received on the job. Of course, labour-intensive manufacturing is not a panacea. Thriving agriculture and services are vital for balanced growth. India's capital-intensive and skill-intensive industries and services can and should continue to grow fast, provided they are efficient and internationally competitive, as many of them now are. But India also needs rapidly expanding demand for low-skilled labour. The only plausible, quantitatively significant, potential source for this demand is labour-intensive exports. An export boom in labour-intensive manufactured and agro-industrial goods could provide extra employment and growth, if infrastructure shortages are overcome, because labour supply is elastic and tradeable inputs could be imported as necessary. As in fast-growing East Asia, profitable exports would boost incentives for companies to save and invest; extra savings would also come from the rising incomes of the new recruits to the industrial labour force. This would help to trigger the virtuous circle of higher savings and investment that is supposed to accompany the demographic transition. 

The policies required to make labour-demanding growth possible are easy to specify but politically difficult to implement. Small-scale industry reservations must be phased out. Labour laws that hinder employment must be reformed. Delivery of primary education must be enhanced. Direct foreign investment should be welcomed in labour-intensive industries. Power and transport facilities, essential for international competitiveness, must be drastically improved. Trade liberalisation must be extended. Special export zones should be put in place. And adjustment assistance should be devised to cushion any adverse short-term effects of the above policies. 

East Asian countries, including China, now face higher labour costs and are moving up the ladder of comparative advantage. That gives India the opportunity to kick-start an export boom, especially as textile quotas are to be abolished in 2005. India currently enjoys economic leadership of enviably high quality. The test of the country's new leaders will be to convince their party and allies the above strategy would be in the interest of the labour force. Without labour-demanding growth, India's "demographic bonus" could have highly unpleasant consequences.

Courtesy Financial Times.
Copyright The Financial Times Ltd 2004