The rise of Indian software industry

Topics: Economics, International trade, David Ricardo Pages: 10 (2323 words) Published: June 14, 2004
The rise of Indian software industry

Question 1

To what extent the theory of Comparative advantage explain the rise of Indian software industry?


Theory of Comparative Advantage

David Ricardo has developed theory of Comparative Advantage. Which was later developed by Heckscher-Olin. They all argued that all countries have different factor endowments of labour, land and capital inputs. Therefore, Countries should be able to specialise in and export products that they can efficiently produce. Comparative advantage says that international trade happens when there are differences in the price of production. (Hill Charles W. 2002).

Ricardo particularly argued that, the gains of specialisation depend on comparative advantage. World production can always be increased if trade takes place between countries, which have different relative efficiencies in the production of any goods or services. If each concentrates on those commodities in which it is relatively more efficient, or relatively less inefficient, a gain is there for the taking. (Hill Charles W. 2002).

Without comparative advantage, there is no reallocation of resources within countries that will increase total world production. (Hill Charles W. 2002).

Comparative Advantage of Indian software industry

The rise of India's software industry, in my opinion clearly explains major part of the theory of comparative advantage. On the first part according to the theory, India has been able to specialize in those goods (software) that it produces more efficiently and at the same time exports it to the countries were software is produced less efficiently. (E.g. US, Europe and Australia). From the viewpoint of the developed countries, (which outsource) are importing goods, which there produce less efficiently. Therefore, this theory mostly focuses on the development of the global economy, where every country can gain benefits in trade.

The Economic gain from trade

The theory of comparative advantage suggests that trade is a positive game in which all countries that participate realize economic gains. (Hill Charles W. 2002).

As in the case of India and U.S., according to Mc Kinsey projected of the year ago that India would generate $ 17 Billion in outsourcing revenues, employing 1.1 million by 2008. Which is huge economical rise for a country like India. This also translates into $ 60 Billion in benefits to the American economy arising from cost savings, new revenues, repatriated earnings and labor redeployment. Given the exponential growth experienced by the India based service centers over the past years, the revenues could reach $25 billion, corresponding to economic benefit to the global economy. This is indeed a phenomenal contribution to global GDP. (Source: India Today August 4, 2003).

Free trade

The basic message of the theory of comparative advantage is that potential work production is greater with unrestricted free trade than it is with restricted trade. (Hill Charles W. 2002).

The unrestricted free trade between the countries becomes a backbone for India and other countries outsourcing to it. Supported by information and telecommunication technologies, which made it possible to trade what has long been locked up within the national borders: skills, talent, ideas, and enterprise. I would say that the rise of Indian software industry provides a strong rationale for encouraging free trade. As both India and the customer countries are strongly benefited and could be a perfect example for Ricardo's theory of comparative advantage in extending free trade argument.

Immobile resources

Resources do not always move easily from one economic activity to another. The process creates friction and human suffering too. While the theory predicts that the benefits of free trade outweigh the costs by significant margin, this is of no comfort to those who bear the costs. Accordingly, political opposition to the adoption of free trade...

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