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1.0 Introduction

According to Heakal R. (2009), an emerging economy can be described as a fast-

growing economy and is in the transitional process of opening its market to the world for

investment. India, for instance, is one such emerging economy. Since 1991 (Bureau of South

and Central Asian Affairs), India had undergone a market-oriented economic reform such as

the reduction in tariffs and trade barriers, and has brought global attention to the country.

However, in the below segment of this worksheet, we will be discussing about the political,

economic and also technological factors that made India an emerging economy.

2.0 Political Factors

2.1 Economic Development Incentives

To attract foreign direct investment (FDI), the government of India has offered

economic development incentives to attract foreign firms through the setting up of Special

Economic Zones (SEZ). SEZs are special duty free zones which promotes exports into the

country (Invest India, 2012).

2.1.1 FDIs due to Special Economic Zones(SEZ)

According to Nishith Desai Associates (2006), SEZ can either be set up by the

government or private sector such as foreign companies. On top of that, the incentives offered

to the developer of these SEZs are very lucrative, such as 100% tax holidays of the export

income of the SEZs for the first 10 years. Due to the incentives received in operating this

SEZ, it is able to attract FDIs like foreign firms to operate in it such as the Special Economic

Zone in Tamil Nadu is developed by Nokia (India Brand Equity Foundation, n.d.).

Besides, incentives such as exemptions from customs duty and service tax provided to

operating units in the SEZ (Nishith Desai Associates, 2006) can also attract more foreign

firms, and therefore, encourage exports. According to India Brand Equity Foundation (n.d.),

exports in the SEZ during 2006-2012 have increased at a compounded annual growth rate of

59% to US$ 78.7 billion.(see Figure 2.1).

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The phenomenon of inward FDIs due to the provision of economic development

incentives by the government through the use of SEZs, can be explained by the concept of

“trade openness” stated by Taylor(2000) as cited in Wall, Minocha and Rees (2010, p.66-67).

“Trade openness” suggests that there is a positive relationship between open trade policies

and inward FDI. Taylor states that countries (like India) that have more open trade policies

(less trade restrictions : tax exemptions in the SEZs) , will be able to attract more inward

FDIs from foreign firms. In conclusion, the economic development incentives provided by

India through the use of SZEs can make India an emerging economy.

Figure 2.1 Exports from SEZs in India (Source: Ministry of External Affairs, Government of

India, Aranca Research as cited in India Brand Equity Foundation, n.d.)

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2.2 Reduced or No Barriers to Trade

To encourage the flow of trade, India has opted actions to reduce its barriers to trade

like reduction in tariffs. By forming a regional trading agreement with other countries or

regional pact like the ASEAN, the government of India is able to form a free trade area with

the corresponding country. Within this free trade area, member countries can enjoy a

reduction or abolishment of trade restrictions such as tariffs between each other, while able to

maintain their individual protectionist measures against non-members (Wall, Minocha and

Rees, 2010, p.107).

2.2.1 India-ASEAN Regional Trading Agreement

A notable regional trading agreement India has formed is that with the ASEAN

countries. Under this agreement, a free trade area of goods and services has been formed

between India and ASEAN that improves economic cooperation, through the relaxation of

trade policies and the elimination of tariff and non-tariff barriers. According to Export-Import

Bank of India (2007), the trade with ASEAN has increased till US$ 30 billion in 2006-07

over the past five years, growing at an average of 31% annually. Interestingly, Export-Import

Bank of India (2007) has noted that during 2001-02, the total trade with ASEAN increased

steadily. Yet, a more proliferating increase can be observed since 2003, when India and

ASEAN has agreed to form the agreement (see Table 2.2). This difference in growth has

proven that regional trading agreements are important instruments used in reducing or

abolishing the barriers to trade to encourage trade.

Table 2.2 Trends in India-ASEAN Trade (Source: DGCIS, Ministry of Commerce and

Industry, Government of India as cited in Export-Import Bank of India, 2007)

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2.2.2 Benefits of Removal of Trade Barriers

Likewise, a reduction in barriers to trade will also be beneficial to countries involved

under the same trade area such as the Indo-Pak trade. As of now, India and Pakistan is

undergoing a slight trade liberalisation such as improvement in procedural management, that

boosts this bilateral trade to US$ 2.6 billion (Zeenews.com, 2012). According to Consumer

Unity and Trust Society (CUTS) International as stated in Zeenews.com (2012), if barriers to

trade between these two countries were removed, India would gain US$ 80 billion whereas

Pakistan stands to gain US$ 1.4 billion, benefiting both countries. This clearly shows that a

reduction or removal of barriers to trade can be beneficial to countries involved. In

conclusion, reduced or no barriers to trade can make India an emerging economy.

3.0 Economic Factors

According to Ernst and Young's India Attractiveness Survey (2012), investors has

seen huge growth opportunities in India due to its rapidly increasing numbers of middle class

group. Besides, the attractiveness survey also found out that India's cost competitiveness has

attracted FDI as well.

3.1 India’s Rise of Middle Class Group

According to Banerji D. and Shah R.(2012), India has recently replaced Japan to

become the third largest economy in terms of purchasing power parity. This achievement can

be explained by the recent rise in numbers of middle class group in India. This rise of middle

class is due to more people moving into the cities to be employed in the growing high-tech

industries (Dunn S., 2012). Since more people are getting employed in the city, this means

that they are gradually earning more and with a higher disposable income, they tend to create

a higher demand for products such as cars (Shukla as stated in The Economic Times, 2011).

The increase in demand for products like cars can be supported by the concept of

income elasticity of demand (IED). According to Wall, Minocha and Rees (2010, p.159-160),

IED measures the responsiveness of demand for a product due to the change in the real

income of consumers. If a rise in real income will shift the demand curve to the right

(increase), this shows that the product has a high (positive) IED value. In this case, the cars

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have a positive IED. Figure 3.1 better illustrates the effects of more of a product X (cars)

being demanded at any given price of X due to an increase in real income.

Figure 3.1 IED curve showing the increase in demand due to the rise in real income

(Source: Wall, Minocha and Rees 2010, p.160)

3.1.1 FDIs from Major Car Industry Player

As investors have realized the growth of this middle class group, there has been a

gradual increase in FDI in the car industry. According to Philip L. (2012), BMW Group has

upped its investment to US$ 106 million in 2012 from US$ 50 million in 2010. This

increment in investment will be used to enhance the group’s product and service offerings so

that the Indian consumers are attracted to purchase more cars. Besides, Volkswagen also

foresee the opportunity created from the rising middle class, therefore, the group also decides

to invest US$ 130.8 million in the next two years to further upgrade its products and facilities

(The Hindu, 2012). As the 160 million middle class individuals in 2011 are expected to grow

to 267 million in 5 years (The Economic Times, 2011), more industry will see this as an

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opportunity and invest more. Consequently, FDI inflows of car companies into India due to

the rise in spending power of middle class Indians will make India an emerging economy.

3.2 Cost Competitiveness Environment

Another reason that enabled India to become an emerging economy is the low labour

cost that the country possesses. According to The Hindu Business Line (2012), India will

soon take over China as the key supply of low-cost labour. The article also states that India’s

main advantage is in its supply of an estimated 85 million college-educated worker by 2030,

second to that of China. In a recent research done by 2point6billion.com (2012), it showed

that India has a relatively lower minimum wage levels as compared to China in the year

2012(see Table 3.2).

Table 3.2 Minimum Wage Levels in China and India (Source: 2point6billion.com, 2012)

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In this case, India has a comparative advantage over China in terms of its supply of

low-cost skilled labour. According to the Heckscher-Ohlin (HO) theory (Wall, Minocha and

Rees, 2010, p.87-89), a labour-abundant country will be able to produce (and export) labour

intensive products relatively cheaper than a labour scarce country. According to Ernst and

Young (2011), India has a large young workforce, a median age of 25 compared to age of 34

of that in China in 2010. Besides, India also contains a large pool of English-speaking

workforce, having an estimated 2 billion English-speaking people by 2020 (Ernst and Young,

2011), an advantage that China does not have. So, based on the human capital version of the

HO theory, India will have a comparative advantage over China as it is able to supply a

young and large pool of skilled labour at a lower cost than China.

3.2.1 FDIs from the Manufacturing Industry

With its cost competitive environment to work in, it has attracted many FDIs

especially that of the manufacturing industry. According to the Ernst and Young’s India

Attractiveness Survey (2012), 45% of their respondents with international presence cited that

the attraction of low labour cost and inexpensive manufacturing facilities are the main

reasons that made them invest in India. During 2011, having a total of US$ 58,261 million of

FDI inflows, 71% of the amount went into the manufacturing industry and it helped created

320 projects as well as 144,449 jobs. Specifically, exports of electronic goods manufactured

in India rose by 56% whereas the imports of electronic goods from China fell by 32% during

2010-2011 (Seth S., 2011). This increase in exports is due to the rising labour costs occurring

in China as investors seek to India for its competitive pricing as well as its inexpensive

manufacturing capabilities. Therefore, FDIs from the manufacturing industry in the coming

future will create more employment and make India an emerging economy.

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4.0 Technological Factors

According to Business Portal of India (2012), due to lower cost structure, India has

emerged as the 21st century's software powerhouse, becoming an ideal destination as a global

hub for outsourcing, especially in the business-process outsourcing (BPO).

4.1 The Business-Process Outsourcing Industry

During 1996, when British Airways set up data entry work and American Express set

up call centres in India (Businessworld as cited by Webmaster, 2010), such business-process

outsourcing(BPO) services has ever since led India to become the leading offshore

outsourcing market in the world with a 58% share in 2012 (Thirani, N., 2012).

According to Porter’s diamond (Wall, Minocha and Rees 2010, p.90-91), India’s

competitive advantage in the BPO industry can be determined by four key variables. India

has a favourable demand condition as the local market demands for more voice-based

(including local language) services (NASSCOM Strategic Review, 2012). India also has a

favourable factor condition as it provides an unparalleled source of skilled talents

(NASSCOM Strategic Review, 2012). A favourable firm strategy, structure, and rivalry also

determines India’s competitive advantage as leading outsourcing industry players (Infosys

and Wipro Technologies) are able to deliver value to customers, by having a re-engineered

business structure and also focus on delivery innovation (NASSCOM Strategic Review,

2012). Besides, a favourable related and supporting industry determines the outsourcing

industry as India’s competitive advantage, due to the improvement in India’s technology

infrastructure (e-Governance projects), with the USD 1 trillion investment from the

government (NASSCOM Strategic Review, 2012).

4.1.1 Exports to Advanced Countries

As the BPO industry grew, it has attracted many customers from the Americas and

Europe and local outsourcing companies has started to export its services to these advance

countries. For example, Tata Consultancy Services has offered cost-effective software

solutions in telecommunication to Ericsson worldwide in 2001 (The Economic Times, 2012).

According to Figure 4.1, it showed that the IT-BPO service industry’s exports have gradually

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increased from the year 2008 to the year 2012. The increase in exports is mainly due to

contribution by major BPO companies like Tata Consultancy Services and also the cost

savings these companies are able to provide (see Table 4.1). Due to the attractiveness of cost

savings provided by the Indian outsourcing companies, the exports to advanced countries will

also be expected to rise in the future and make India an emerging economy.

Figure 4.1 IT-BPO Revenues (Source: NASSCOM, 2012)

US$ Cost per FTE(Full Time Employee)

United States India India as % of US costs

Personnel 42,927 6,179 14%

G&A Expense 8,571 1,000 12%

Telecom 1,500 2,328 155%

Property Rentals 2,600 847 33%

Depreciation 3,000 1,500 50%

TOTAL EXPENSES 58,598 11,854 20%

Table 4.1 Cost savings by the US for outsourcing to India (Source: Industry Sources, Merill

Lynch 2003 from the Nasscom Strategic Review as stated by Webmaster, 2012)

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5.0 Recommendations

5.1 Political improvement

5.1.1 Increase Transparency of FDI and Incentive Process in SEZ

Ever since India introduced the use of SEZs to promote FDIs, it has greatly improved

the trade flow between that of India and foreign investors. Although SEZs in India have been

performing well, but the provision of incentives, if left unchecked , the FDIs could eventually

cause the misallocation of resources and even corruption (Raj N.and Sager E., 2005).

To avoid such a problem from happening, the government of India should raise the

transparency of the process of FDI and incentive, especially at the SEZs governed by private

companies. The government of India can increase this transparency by quantifying the

incentives given. Instead of being made a provision, the incentives should be made in a cash

based transaction or in other easy to understand methods (Raj N.and Sager E., 2005). By

doing so, the Indian government and parties involved are able to monitor and analyse the

transactions being made. Thus, problems such as resource misallocation and corruption are

minimized and even avoided.

5.1.2 Change to a Freeport

Besides being transparent, the government can also opt to upgrade the SEZ to a higher

standard operating zone. This can be done by upgrading it to a modern version of the SEZ,

called a freeport. According to Roy J.and Banerjee P. (2007), a freeport is a suitable concept

for countries wanting to become a developed country. A freeport resembles very much of that

of an advanced country's SEZ in terms of its trading environment. It will be functioning in a

less trade restriction, smoother flow of procedures, sound infrastructure and convenient

access to world-class ports and airports. Roy J.and Banerjee P. (2007) also states that

freeports are able to attract small and medium enterprises (SME) type of businesses. If that is

the case, this means that India will be able to gain more exports not just from major

companies, but also the cream market of the SMEs.

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5.2 Economic Improvement

5.2.1 Increase Labour Productivity to Maintain Cost Competitiveness

Even though India still maintains a cost competitive edge over many countries such as

China, Thailand and Malaysia (Devonshire-Ellis C., 2011), yet it still faces a severe threat of

being taken over by Vietnam which is also able to offer low wage costs (Mason P., 2010).

According to a comparison made by World Economic Forum as stated in Business Standard

(2012), India's global competitiveness ranking has slipped from 49 during 2009-2010 to a

position of 59 during 2012-2013 (see Table 5.2).

Table 5.2 India's Competitiveness Ranking Comparison during 2009-2010 to 2012-2013

(Source: World Economic Forum as cited in Business Standard, 2012)

Even so, India can still maintain its status as a cost competitive country in accordance

to relative unit labour cost (RULC) as global competitiveness is related to it. According to the

concept of RULC, RULC is a tool used to calculate the international competitiveness of a

country (Wall, Minocha and Rees, 2010, p. 9 and 10).

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According to the formula of RULC, it stresses that lower RULC computes to higher

competitiveness. To achieve lower RULC, India either has to reduce relative labour costs, or

by increasing its labour productivity. Since India already has low labour costs, all India has to

do now is to increase its labour productivity to ensure its global competitiveness.

One of such ways to raise labour productivity is to increase the education level in

India. Indians have to be more educated so that they can be more productive. This is

supported by a study by Sandra and Lynch (1996, as cited by Jajri I. And Ismail R., 2009)

that shows that there is a positive relationship between years of schooling and productivity.

Besides, labour productivity can also be raised by giving proper training to workers. Jajri I.

And Ismail R. (2009) stated that workers who attended these trainings will be more efficient

and productive, and therefore, increase in productivity growth. Lastly, having a leaner

production can also raise labour productivity. For example, IBM developed an Application

Assembly Optimisation approach. It is applied in the car manufacturing industry whereby it

breaks up broader works into smaller works and flow it into an “assembly line”. This process

produced a 20-30% increase in labour productivity as workers are more specialised in those

smaller works (Carroll A.M., 2011).

5.3 Technological Improvement

5.3.1 Sustain India's Cost Advantage

Although India currently remains as the leading business-process outsourcing (BPO)

country in the world, its position is still threatened by other emerging economies such as the

Philippines. According to Bajaj V. (2011), the Philippines took over India as the leader in the

call centre outsourcing services in 2011, due to their Americanization way of interaction with

customers as compared to the British-speaking Indians.

Nevertheless, one suggestion that India can still maintain its cost advantage in other

services like the voice-based and data entry services is by relocating the BPO hub to smaller

cities (known as Tier II/III cities in India). According to the NASSCOM-Everest India BPO

Study (2008), BPO companies that allocate their operations to smaller cities are able to save

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up to 20-30% of their existing total operating costs. At the same time, BPO companies are

also able to effectively uncover more talent pools across several states in India.

5.3.2 Move up the Value Chain

If India is unable to sustain their low-cost leadership position, another suggestion is

that India's BPO industry should move up the value chain and enter the higher end knowledge

work industry, known as the knowledge-process outsourcing (KPO). In the future, India may

not remain low-cost due to increase in wages (Aggarwal A.and Pandey A., 2004). Besides, as

the BPO reaches maturity and boosted by the higher profit margin in the KPO, India will shift

its focus to the KPO industry (Aggarwal A.and Pandey A., 2004).

6.0 Conclusion

Ultimately, there are three main factors that make India an emerging economy: the

political, economic and technological factors. Political factors like the economic development

incentives and reduced barriers to trade, and also economic factors like the rise of India's

middle class group and cost competitive environment can altogether make India an emerging

economy. Meanwhile, the technological factor like the established business-process

outsourcing industry will also make India an emerging economy. Yet, political improvements

like increasing the transparency of process in the SEZ or changing it into a freeport can

further sustain India's economic growth. Besides, economic improvement like increasing

labour productivity, and technological improvements such as sustaining cost advantage or

move up to the KPO industry can also sustain India's economic growth.

(Word Count: 3005 words)

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