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.

It's Called Rum, Vijay

With a population of more than a billion people, rapidly rising prosperity, and a more and more Western popular culture, India represents a tremendous opportunity for Western companies, particularly those that manufacture or sell consumer products. One problem for them has typically been that India's trade policies since independence have been resolutely protectionist. Although that has changed somewhat in recent years, protectionist tariffs still represent a considerable barrier to entry. Take, for example, liquor: import duties on foreign liquor can be up to 550% ad valorem. At that rate, even the cheapest American or Scottish rotgut would cost $40 or more a fifth in India, and the price for decent liquor like Johnnie Walker Black Label could easily be over $100 a fifth. Friday's Wall Street Journal has a front page article ("Western Liquor Makers Eye Rich Indian Market") that explores the potential and the problems of the Indian market for big Western spirits companies like Diageo (which owns Johnnie Walker and many other liquor brands), Pernod Ricard (Glenlivet, Chivas Regal, Ballantine's, etc.), and Fortune Brands (Jim Beam, Laphroaig, Dalmore, etc.).

Problem #1 is the aforementioned exclusionary tariff rate. Problem #2 is a traditional antipathy to alcohol by both Muslims and Hindus, who make up the vast majority of India's population. Gandhi famously disliked liquor, and his home state of Gujarat still bans it. Nationwide prohibition was attempted as recently as 1977, and alcohol advertising is still completely banned. Problem #3 is Vijay Mallya, whose United Spirits company has a stranglehold on the Indian spirits market (his beer company, Kingfisher, likewise has the lion's share of the Indian beer market). Modernization has helped to break down the anti-alcohol taboos in India, particularly in the cities, and Mallya and his company have been very successful at grabbing market share through Western-style marketing and distribution practices. If the Western spirits companies succeed in getting Indian liquor tariffs repealed or reduced, they're still going to have to deal with Mallya.

All of this is very interesting, but there were two sentences in the article that was almost an aside that caught my attention:

Indian whiskies are usually made of sugar-cane molasses, and can be bitter. Western whisky is made of grains.

We have a name for a distilled spirit made from a mash of sugar cane and/or molasses. It's called rum. There is nothing wrong with rum, and, when properly made, it can be sublime (Ron Zecapa Centenario 23 year old is an example of a sublime rum). But it is not whiskey. It is not better or worse for not being whiskey; it's simply a different category. Beer can be wonderful. So can wine. But beer is not wine, and wine is not beer. United Spirits wants to call their rum whisky because whisky apparently has more prestige in India than does rum. Well, tough. It must be made from grain to be called whisky. Calling a molasses distillate whisky twists the meaning of the word so severely that it can no longer be said to have any meaning. For shame, Vijay Mallya!