What Do You Know? Economics Works!

There is a front-page article in last Tuesday's Wall Street Journal that discusses the increasing difficulties some American firms are having with outsourcing software development to India ("Some in Silicon Valley Begin to Sour on India", p. A1). As is typical of Journal articles of this sort, it mixes anecdotes with more general statistics, in this case to portray wage inflation and the accompanying job turnover in the Indian tech sector as reaching uncomfortably high levels.

The result [of the limited pool of qualified software developers who have the language and technical skills to work for American companies] is increasing competition for the most skilled Indian computer engineers and a narrowing U.S.-India gap in their compensation. India's software-and-service association puts wage inflation in its industry at 10% to 15% a year. Some tech executives say it's closer to 50%. In the U.S., wage inflation in the software sector is under 3%, according to Moody's Economy.com... [T]he experienced engineers Silicon Valley companies covet can now cost $60,000 to $100,000 a year... Increases like that [in compensation] have spurred a lot of job-hopping in India. Pervasive Software Inc. of Austin, Texas, opened a Bangalore unit in 2004 and hired 45 people. But soon its turnover was more than 25% a year, says the company's CEO, John Farr. The company kept having to invest in training workers, only to see them leave. A year ago, it shut its Bangalore unit.

What I read in this story matches the anecdotes that I have heard about Indian outsourcing recently. I have heard stories from more than one friend or colleague in the industry about terrible problems with turnover: they get good people trained up, and those good people leave for a better salary. That's not surprising, and I can't blame the Indian programmers who do this. However, it does significantly change the value proposition of outsourcing software development to India. Major outsourcing companies have responded by opening up shops in places like China, Mexico, Poland, and Brazil. The wages in these new places are significantly lower than they are now in India, but they also don't have some of India's advantages. Because of the good Indian system of technical education and the fact that the language of education there is English, India has a large pool of qualified people who speak English. Countries like Poland and China likely have large or at least significant pools of people with the technical skills, but English is not nearly as pervasive there as it is in India. Mexico and Brazil have an advantage in that the time difference between them and the United States is small or non-existent, but I wonder if they have large enough populations of people with the necessary technical skills.

Too many managers in the US have believed that they can save tons of money on software development by simply outsourcing it to India. Well, guess what, guys? The law of supply and demand works in India just like it does here. If the demand for Indian-based software developers increases dramatically and the supply of qualified Indian-based software developers remains relatively static, the cost of obtaining the services of some of those developers will also rise dramatically. The same thing will happen as more companies move into China, Poland, and elsewhere. Outsourcing is not a magic bullet that will slash the cost of software development to nothing, no matter how much US managers wish that it was.