Why India’s Software Firms Prosper

Ashish Arora, an economist, is a professor at the Fuqua School of Business, Duke University. He is an editor of "From Underdogs to Tigers: The Rise and Growth of the Software Industry in Brazil, China, India, Ireland, and Israel."

UPDATED NOVEMBER 7, 2010, 7:18 PM

At the vanguard of India’s economic growth have been software firms like TCS, Infosys and Wipro. How was a poor country able to compete internationally in a high-tech sector?

India's growing software industry flew under the radar of a government bureaucracy and red-tape.

It’s true that India had a large pool of engineers, willing to work for low wages. But how did a country, with a per capita income of less than $500, produce so many engineers? And why were other countries, better endowed with engineering talent, like the Philippines and Russia, unable to replicate what India managed?

Although luck played its part, India succeeded in software because of its entrepreneurs, and because India had opened up and connected to the world economy.

After a decade and half of miserable growth, India started to liberalize its economy in the mid 1980s, so that it was well prepared when the I.T. boom opened a window of opportunity in the early 1990s. American multinationals played their part as well. Firms like Citigroup, Motorola and Texas Instruments showed that India had good software talent, and Indian software entrepreneurs seized the opportunity.

That a country where large-scale private enterprise had mostly consisted of exploiting profit opportunities opened up by regulations could create so many entrepreneurs is remarkable. Even more remarkable is that the software industry could become a catalyst for economic growth. These entrepreneurs came from all parts of India and from the extended Indian diaspora in America.

India had become connected to the broader global economy (and especially the U.S.) in many different ways. India was connected through a common language, English; through economic liberalization in the 1990s that opened the country to foreign trade; and through its diaspora which connected the nascent software industry to its clients in America and Western Europe.

Nonetheless, the growing software industry would have run out steam pretty quickly as the wages of existing software engineers got bid up, or as the firms got snarled in bureaucratic red-tape. Neither happened. The software industry flew under the radar of a bureaucracy pre-occupied with promoting computer hardware and semiconductor chips.

Software did benefit from various policies aimed at boosting exports. (though none was aimed at software). However, the major policy innovation vital to the continued growth of the software sector was also inadvertent. Unlike many other aspects of the Indian economy, education was not the sole province of the federal (central) government. By happenstance, some states, such as Karnataka, whose capital Bangalore is now popularly (and incorrectly) regarded as India’s Silicon Valley, had allowed private engineering colleges.

These private colleges, which did not look to the state for their subsistence, turned out an army of smart and eager engineering graduates. The prospect of earning a decent salary through an engineering degree drew in many more young men and women, in turn attracting other “academic entrepreneurs” to start new colleges.

One lesson from this experience is to be open. The United States, which has benefited tremendously from its open embrace of the world, is in the danger of becoming less open, less connected, less welcoming to the outside world. The poisonous debate on immigration, the “war” on terror, and economic protectionism are making the United States less welcoming to talented and ambitious foreigners, who will help drive the next wave of innovations in information technology, health, energy, and the environment.

Second, let market forces decide who survives and who flourishes. Indian software firms spurred economic growth because they were run transparently by men who were also willing to share their good fortunes with employees and shareholders.

Indeed, for the first time in India, wealth was seen to be created in an honest and transparent fashion, eliciting not scorn, but admiration. The consensus in India in favor of market-based growth has not wavered despite many changes in the party in power.

This is not new for America, which has been a beacon to the rest of the world for how public corporations should be governed and managed. But we also need to do more to improve how sectors like finance and health care are managed. (I am struck by how little personal responsibility the leaders of the financial sector have accepted for the debacle which has triggered the recent crisis, even as they and their employees pocket enormous pay packages.)

Standard policy prescriptions for stimulating innovation — creating clusters, giving tax breaks to venture capital, subsidizing R&D, or targeting specific industries for preferential treatment — do not hurt. But what really matters are the basics: the supply of talent, connections to the outside world, and the freedom for entrepreneurs to experiment (and fail).

NYT