Finance @ Knowledge Zone


U.S. Software Outsourcing
Analysis Of Factor-Price Equalization Theory

- by Bhaskar Roy *

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Part - II

So this has enabled few new things -

  • Firms can borrow in U.S. and invest in India - so capital cost in U.S. may not increase - recent trend shows, lot of VC firms are interested to open shops here directly.

  • Firms can manage their work easily from U.S.

  • Indian labor supply to IT industry seems unstoppable (because of huge population and young generation trend) - labor cost in India may not increase - India is producing highest number of Computer Science graduates in world. Although there are wage increases in India but the average wage will be low, because of huge supply.

  • Reverse brain drain is bringing more high valued work.

  • Within India the labor wage varies a lot amongst different regions.

4. Analysis

The mobility of the factors of production (capital, equipment, knowledge, information, management expertise, even raw materials) makes it easy to ship IT and other knowledge-worker jobs overseas. Any and all factors of production are now mobile. This is a new economic phenomena and it's diminishing the US' comparative advantage in the world. The countries with the least expensive labor now have an absolute advantage over the US and Western Europe! Long-term price factor equalization will fix this as third-world labor rates rise and first-world rates drop (this is why economists say our job losses are OK) but this will take several generations. In the mean time, knowledge-worker jobs (not just IT jobs) in the first-world will continue to move to the third-world. Mobility of factors of production negates comparative advantage. Most economists mistakenly think that losing US jobs is OK because they've failed to consider the impact of mobile factors of production - the loss of the US' comparative advantage! So US may loose competitive advantage in a world where even raw materials are mobile.

5. Conclusion

So the factor price equalization theory may not stand for software outsourcing, because the fundamental conditions for the theory are getting changed. Rather the recent trends allowing the price cut for software solutions, and creation of upward vicious cycle in India.

Concluded.

* Contributed by -
Bhaskar Roy,
B.Tech. (Civil Engg), IIT Kharagpur,
PGDBM (Marketing), XIME Bangalore,
Currently working as Project Lead in Oracle India Pvt. Ltd.